Even though the US and Europe have experienced the collapse of several banking institutions this year, experts are doubtful the same situation will occur in Australia.
When Australian regulators, bankers and directors woke up on 11 March to news that Silicon Valley Bank (SVB) in the US had failed after a bank run, comparisons with the 2007–08 global financial crisis (GFC) were inevitable.
The biggest US bank collapse since the GFC at the time, and the subsequent failure of two more small US banks, as well as the Swiss banking giant Credit Suisse, raised the spectre of another recession-causing credit crunch. The scenario was reinvigorated when First Republic Bank (FRB) became the second-largest bank failure in US history on 1 May. Most of the business of the San Francisco-based regional bank was sold to JPMorgan after federal regulators seized it following a run on deposits and a collapse in its share price.
In interviews with Company Director, conducted in early May, economists and banking analysts said that while such an outcome is unlikely and Australia is well-shielded from any fallout, there is still no room for complacency. “I wouldn’t want to suggest it’s OK to relax,” says Wayne Byres GAICD, former Australian Prudential Regulation Authority (APRA) chair. “There will be economic and financial turbulence as the world adjusts to higher interest rates. Asset prices will come under pressure as rates rise further. But there is no doubt the global banking system is more resilient than it was in 2008.”
The world’s banking system has “multiples” in terms of more capital and liquidity than it did before the GFC thanks to reforms developed in its wake by the Bank for International Settlements (BIS), known as Basel III. Periods of stress are easier to withstand and contagion much less likely.
Causes of collapse
The US has more than 4500 banks, about 4000 of them small, and the collapse of three should be seen in this context. And no customers lost deposits, thanks to US bank deposit insurance. The recent collapses were caused by a set of circumstances particular to smaller regional US banks. Many had a high reliance on a single market. SVB, for instance, banked a high proportion of tech businesses. As the value of tech investments fell, their tech company customers drew on their deposits to make up funding and liquidity shortfalls.
At the same time, SVB had invested heavily in US Treasury bonds. While considered among the world’s safest investments, their value fell sharply as interest rates rose (bond prices move inversely to interest rates). Concerns in US tech circles that SVB’s assets did not cover its liabilities led to a run on the bank by depositors and ultimately its seizure by the Federal Deposit Insurance Corporation (FDIC).
The March collapse and sale to UBS of Swiss bank Credit Suisse came after its largest shareholder, Saudi National Bank, declined to put in more funds.
Banks in Australia are more diverse in their customer base and APRA has a set of robust capital and liquidity standards that apply to all banks. In fact, Australia’s regulated prudential safeguards are above and beyond minimum international requirements.
In the US, the most stringent liquidity requirements applied only to the largest US banks, leaving many of the smaller banks exposed. Smaller banks can effectively choose to be more lightly regulated by state bodies rather than by the national regulator.
Who’s to blame?
Byres places the blame for the US’s bank collapses squarely on their directors and management, saying they should have been prepared for the rapid rise in interest rates by central banks as they sought to tame inflation. SVB, for instance, failed to extrapolate how its balance sheet would be affected if interest rates continued to rise.
In addition, there were possibly supervisory, regulatory and auditing failures in how the banks were regulated. “Even if there were, I don’t think anything should detract from the primary responsibility of bank boards and management to be prepared for reasonably foreseeable risks,” says Byres.
ANZ Banking Group chief economist Richard Yetsenga GAICD agrees, saying US bank problems stem more from business decisions taken at the individual institutions rather than systemic problems that might apply across the bulk of the financial system. There was only ever a very low chance that the rapid inflation- fighting interest rates in the US wouldn’t cause problems somewhere.
Also, private sector balance sheets in the US are in a much stronger place than they were two decades ago, so the US is likely to be less affected by high interest rates and bank problems. To the extent that it is, there’s likely to be less transmission to other countries than there was during the GFC, when large amounts of US dollar lending by global banks to other countries left them vulnerable when America ran into problems, says Yetsenga.
While there’s likely to be some modest credit tightening — less lending — in the US as a result of these collapses, the main transmission to Australia will be thanks to the US status as the world’s largest economy and the cooling effect tighter credit conditions will have on that economy. “There’s likely to be an indirect impact through bond yields,” says Yetsenga. “The US bond yields have declined since SVB’s problems back in March and that has had some spillover into the Australian market by bringing Australian bond yields down, as well.”
Certainly, current APRA chair John Lonsdale is confident about Australian banks. He told the Australian Financial Review Banking Summit in March that he had “confidence that the banking system here is among the best-equipped in the world to handle a crisis”. Lonsdale added that the results of a stress test scenario conducted by APRA on the 10 largest banks underscored the strength of the Australian banking system. It showed that depositor funds would be safe even if the economy declined by four per cent, unemployment rose to 11 per cent, house prices fell by over 40 per cent and then every bank was hit by a cyberattack.
Even so, Deloitte Australia banking sector and capital markets leader David Myers warns that Australia’s “over-dependence on property” does create some vulnerabilities. “The concern I would have now is how are the banks positioned,” he says. “Whether it’s residential or commercial, are people going to be under strain to make their payments? And what does that mean in terms of defaults and so forth?”
As for how individual businesses should position themselves, Myers says that most large companies will have a couple of different banking relationships to provide a bit of flex. Directors should be ensuring the CFO has a good understanding of their banks’ positions. They should ask management how they are seeing the crisis, who they bank with and how they view the relationship. Large companies will be using a wide range of bank services, ranging from trade finance and lending through to purchasing derivative products to perhaps hedging currency exposure.
“It would be a much more sophisticated review of the lending processes as well as their trading processes and the overall capital and risk management,” says Myers. “It’s just understanding what and how — what the bank is actually servicing in terms of other customers that may be in my sector or out of my sector. Is that going to create a knock-on effect for me?”
Navigating the risk
Although most commentators expect only limited spillover from the US bank collapses, none says there is zero risk of more serious consequences. “If you’re swimming in the ocean, you know that there are sharks there, and you never know whether the sharks will come at you or not,” says Dr Fariborz Moshirian, director of the Institute of Global Finance and a professor of finance at UNSW Business School.
“The worst scenario is we end up with bank runs,” he says. “People lose their confidence in our banking system. Banks also stop lending money to each other because they will be worried if they’ve got a strong balance sheet. That could trigger a sharp and sudden decline in prices, economic activity, confidence in general for investment — it has a domino effect.”
Moshirian says that as unlikely as such an eventuality might be, companies should be prepared. They should diversify their banking relationship and, if they’re investing, they should diversify their portfolio and also diversify on a regional basis. Companies should ensure they’re not rewarding staff who take too much risk, which was one of the causes of the GFC. “We want a stable return, without too much volatility.”
Byres agrees that the situation isn’t without risk and much will depend on whether central banks are able to contain inflation and generate a soft landing without resorting to much higher interest rates. If not, then it’s possible that some banking systems around the world — particularly those starting from less strong positions than Australia — would come under significant stress as a result of recessionary conditions and the impact of falling asset prices.
“If there was widespread fragility in the global banking system, Australia couldn’t avoid being impacted,” he says, adding that Australia doesn’t have the fiscal and financial firepower that it had when it went into the GFC.
“Navigating through shocks is part of doing business. It requires a continued focus by directors on building a balance sheet and operational resilience in good times, and having contingency plans in place that provide a menu of options that can be quickly deployed when adversity unexpectedly hits.”
In its latest Financial Stability Review, the Reserve Bank of Australia (RBA) says it’s confident the global banking system will remain resilient, despite the US collapses exposing vulnerabilities. However, it also notes that confidence in some banks remains fragile — particularly those with business models that leave them susceptible to deposit flight — and if further stresses were to affect banks around the world, it would feed through to tighter financial conditions.
“A key risk is that a further substantial tightening in financial conditions leads to disorderly declines in asset prices and disruptions to financial system functioning,” states the RBA. “Large and disorderly declines in financial asset and property prices resulting from higher interest rates and increased risk aversion could disrupt key funding markets and strain the balance sheets of some borrowers and lending institutions.”
This article first appeared under the headline ‘Banking On Being Better’ in the June 2023 issue of Company Director magazine.
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