The collapse of three US regional banks and the selloff in Credit Suisse shares are driving fears about the health of the global financial system.
This is not 2008
The current banking crisis is drawing comparisons to the great financial crisis of 2008 when the downfall of Lehman Brothers spiraled into a global financial crisis. We believe 2023 bears little similarity to 2008, however.
The main issue in 2008 was solvency. There was too much leverage in the financial system. Bank balance sheets were loaded with billions of dollars in toxic mortgages and complex derivatives. Today, the issue is duration, not solvency.
The banking industry is fundamentally healthy today. Goldman Sachs reports that many banks today hold more cash, fewer risky real estate loans, and have lower loan-to-deposit ratios, compared to the great financial crisis.
In 2023, financial cracks are emerging from the most rapid rate hikes since the 1980s. Some banks are struggling with a mismatch in the duration between assets and liabilities. Their balance sheets are too exposed to long-term Treasuries. Although US Treasuries are extremely high quality, they are subject to interest rate risk, or duration. Some banks are facing billions of unrealized losses driven by the Fed’s aggressive rate hiking policy. When banks tried, unsuccessfully, to sell bonds to shore up their finances, that triggered a panic — basically, an old-fashioned bank run as depositors withdrew cash.
Deposits, long seen as a reliable source of bank cash, have now come into question. The collapse of Silicon Valley Bank set off fear among depositors that led to the failure of Signature bank and the move to rescue First Republic bank. Regulators are acting quickly and aggressively to restore confidence in the financial system.
Not all areas of the market are performing badly
The overall stock market is hanging in there. While regional bank stocks, cyclical stocks, and commodity-related stocks have dropped recently, other areas such as technology stocks have rallied. This suggests that investors believe that the banking collapse won’t bring down all areas of the economy.
Yet a bank crisis warrants attention
We don’t take any bank crisis lightly. Regional banks are important to the overall economy. Smaller banks account for around 38% of all outstanding loans, according to the Wall Street Journal.
- Risk of a credit crunch
Banks are likely to respond by tightening standards and slowing lending. If it’s harder to get a loan, simply because small banks must re-capitalize their balance sheets, then the economy could weaken.
- Risk of recession
Goldman Sachs said that growing stress in the banking sector has boosted the odds of a US recession within the next 12 months to 35% chance, up from 25% before.
Is my cash safe?
If you have less than $250,000 at an FDIC-insured US bank, then you can rest easy. Joint accounts are insured up to $500,000. If you have more cash than that, speak with your Signet financial advisor about ways to protect your assets, while also generating income. We prefer short-term government bonds and FDIC-insured CDs for income and safety.
- Don’t ignore the banking crisis, but don’t panic either. This could turn out to be very minor, but this is the type of event that tends to ripple through the economy.
- Interest rates have risen a lot more than people expected, and we’re starting to see stress. There is uncertainty about whether there are more cracks from the aggressive rate hikes of the past year.
- Signet will continue to monitor the situation closely to make sure our clients’ portfolios are positioned appropriately.