Are banks on the brink of another 2008-style meltdown?

Northern Rock, Bear Stearns, Countrywide Financial and Alliance & Leicester. In late 2007 and early 2008, when they all failed or were bailed out, none of the above were systemically important. Few observers would have predicted the nightmarish crisis that would unfold within a year, from Wall Street venerable Lehman Brothers to the Royal Bank of Scotland, then the world’s largest bank.

Fifteen years later, after a week in which four banks—Silicon Valley Bank, Signature and First Republic in the United States, and Credit Suisse in Europe—moved and were propped up in one way or another, it’s no wonder investors are questioning whether the 2007 we are facing similar problems, which may soon lead to another 2008-style disaster.

We have good reason to hope not. The primary causes of the 2008 crisis—the glut of subprime mortgages that were spread through derivatives onto the balance sheets of poorly capitalized banks around the world—will not prevail in 2023. Credit quality remains adequate. Bank capital is two or three times stronger than a decade and a half ago.

Such reassurances felt hollow in the face of market panic in bank stocks. European banks are in the red on average 19 percent two weeks later; By American banks 17 percent. On Wednesday, Credit Suisse shares plunged 30 percent during the day and only recovered after the central bank intervened.

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The markets were not completely calm by the end of the week, but they stabilized somewhat. This happened after the CS used the Swiss National Bank’s $54 billion “bazooka” liquidity intervention, while the risk of a run on American banks was offset by deposit guarantees, new Federal Reserve liquidity structures and the whip of Wall Street.

Of course, such interventions would not have been necessary after the 2008 drama. The massive package of post-crisis regulatory reforms was designed to prevent a repeat of the domino collapse of banks on both sides of the Atlantic. New minimum capital levels have been drawn up, regulatory stress tests have been introduced and liquidity ratios have been tightened, dictating that more ready funds are available to meet customer withdrawal requests.

This week’s problems in the United States were specifically caused by the fact that these rules were not applied to anyone but the eight largest banks there. A combination of poor interest rate risk management and lax regulatory oversight brought SVB to its knees, leaving it vulnerable to deposit withdrawals.

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Hours later, a crypto-centric bank called Signature was hit by a similar phenomenon. First Republic, another regional bank, became a particular target after panicked investors realized it would not benefit from a special Federal Reserve financing facility launched in the wake of SVB’s bankruptcy because it lacked the collateral required to use the system.

As investors looked for victims in Europe, attention turned to Credit Suisse, long considered the weakest big bank in the region. It shares little or nothing with SVB – its regulatory supervision is strong, its interest rate risk is covered. But it was accident-prone and is being rebuilt slowly. A decade or more of mismanagement and scandals have badly tarnished the group’s reputation – especially bad when so much of the business model depends on getting billionaires to trust you with their wealth. At the same time, long-standing shareholders left the bank to be replaced by new ones that could not be used.

There is even less fundamental reason to distrust the broader viability of European banks. Loan losses are low, capital levels are strong and they have been stress tested.

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But that bullish valuation is still trumped by bear nerves—and some logic. Central bank efforts to curb inflation will trigger recessionary pressures, increasing banks’ loan losses and potentially eating away at capital buffers. At the same time, unexpected damage can occur to less regulated but equally important parts of the financial system that are used to ultra-low interest rates, such as pensions, private equity and hedge funds. The doldrums in the UK pensions market last autumn were a warning sign of such risks.

Even if the chance of another total financial collapse is remote, our ability to deal with it may be diminished. Back in 2008, policymakers were able to cut interest rates, initiate quantitative easing, and flood banks with bailout capital and liquidity. With government balance sheets much stretched these days and interest rates having to be raised to combat inflation, the arsenal at their disposal has dwindled dangerously.

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