Crisis, crisis, everywhere

The collapse of SVB was the largest bank failure since the Global Financial Crisis of 2007/08. Image: Shutterstock

On Friday morning of March 10, state financial regulators marched into the offices of Silicon Valley Bank (SVB), a hitherto obscure (except perhaps to techie types) financial institution. Just two days prior, SVB was a going concern, albeit facing some cash crunch issues. But a combination of urging by certain prominent venture capital executives—amplified by social media chatter—sparked a massive run by depositors, and by Thursday evening, the bank was effectively insolvent. The collapse of SVB was the largest bank failure since the Global Financial Crisis of 2007/08.

The SVB incident was but one of a number of bank failures in March. Two banks with significant exposure to cryptocurrency assets—Signature and Silvergate—were also wound down, and First Republic—a fairly sizable regional bank with operations in 11 states—also had to be bailed out (ironically, by having larger banks extend credit to it, and thereby “bailing in” the rest of the U.S. banking system). Beyond American shores, investment bank UBS had to be arm-twisted into acquiring its longsuffering Swiss competitor, Credit Suisse, and the stock prices of banks in Europe and Japan also suffered significant hits.

The troubled banks faced the loss of confidence from their depositors and investors because they either managed balance sheet risk poorly (as was the case for SVB and Credit Suisse), or were insufficiently diversified (Signature and Silvergate). There may also have been some lapses by regulators; these so-called “non-systemic” banks saw more regulatory forbearance, and on hindsight, stress tests did not appear to cater to the possibility of aggressive increases in interest rates. Still, the overall reason for why now is simply that the rate hike cycle—which is entirely necessary to address inflation, and for which everyone has well been aware of—is clearly the source of challenges for banking systems worldwide. A rising tide tends to lift all boats, but when it recedes, there is a chance of seeing who has been swimming naked.

As the smoke clears and financial markets return to an uneasy calm, it has become clear that the crisis could easily have been more severe. The decisive action by authorities worldwide was necessary to prevent contagion; had the loss of confidence infected markets more broadly, it would have induced financial stresses that would have become a self-fulfilling prophecy. The financial lifelines organized—along with the orderly restructuring of beleaguered banks—was necessary to stem the downturn in sentiment. The Federal Reserve even played the role of responsible global citizen, by extending dollar liquidity facilities to central banks in several other jurisdictions.

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Remarkably, Asian banks and venture capital firms have (thus far) been largely insulated from the turmoil. Part of the reason has been how Asian monetary authorities had learned the difficult lessons from the 1997/98 financial crisis, and many had come to rely on self-insurance, maintaining large stocks of reserves to protect against such financial storms. Asians are also, in the main, huge savers, and this has helped their banks remain adequately capitalized.

But we would be mistaken to think that this means that the region is fully insulated from global developments, or that it has no homegrown issues of its own. In many countries, deposit insurance remains woefully limited, and many governments—especially in emerging Asia—had run up sovereign debt in the aftermath of the pandemic.

Some countries—such as Kyrgyzstan, Pakistan, and Sri Lanka—have seen their foreign exchange reserves erode rapidly, providing only several months of coverage to finance imports. China has experienced a handful of small-scale crises—the most recent being a series of corrupt and fraudulent banking practices in Henan province—any of which could metastasize into larger shocks, and threaten the financial stability of an already highly-leveraged corporate sector (especially in the real estate market).

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Asian economies have been especially hard-hit by the pandemic, and their growth and dynamism will take some time to fully recover. The Federal Reserve has already telegraphed its intention to persist in its rate hike cycle—and to keeping rates elevated in the near term—until still-high inflation comes back down to earth. Yet futures markets have disbelieved this message, and are pricing in an easing of financial conditions by midyear. When expectations finally meet reality, expect some correction in financial markets, including those in Asia.

The implication of all these developments is straightforward: Asian economies and financial systems will remain vulnerable in the meantime, and their policymakers would do well to remain vigilant to risks that could yet emerge.
 
Jamus Jerome Lim is Associate Professor of Economics at ESSEC Business School, Asia Pacific.