Don't bank on it being a crisis

Within the last week we’ve seen three US banks collapse and now perhaps more significantly Swiss banking giant Credit Suisse appears to be in trouble and needs to raise more capital. Fear of contagion is extremely high because many remember the flow-on effects of the GFC all too well. Although necessary, interest rates going up so high so quickly to slow inflation will ultimately break something in the economy at some point. I have been sitting on cash patiently waiting for the catalyst to appear that would send share markets falling back to their lows of 2022. That’s the buying opportunity we are waiting for. The current issues in the banking system sound bad and have damaged confidence significantly, however I am not convinced that this is the systemic threat that markets seem to fear it is. That said, these sorts of situations can escalate quickly, and can be unpredictable so I am certainly mindful of that too.  

Firstly, to really understand the current situation we need to separate the US bank failures from the Credit Suisse issues. They are not related. Credit Suisse has been poorly managed for years and the current need for more capital is not really a surprise. The issue came to a head yesterday when the chairperson of the Saudi National Bank, the largest shareholder in Credit Suisse, said they wouldn’t supply further funding if the bank needed it. Investment markets started to fear the worst. I would expect swift intervention from the Swiss Government or Central Bank to provide the funding needed to stabilise the bank. That will prevent systemic risks from coming into play. It will cost the Swiss taxpayers and Credit Suisse shareholders significantly but for the rest of the world it’s business as usual.  

In the US, the Silicon Valley Bank (SVB) collapse was effectively the result of the bank having so many deposits that they had to invest surplus funds and did so in only longer dated bond style investments. When interest rates increased and SVB had to cash in some of these investments earlier than they expected, they had to realise losses on those bonds. That spooked depositors, many of whom were in the tech industry in Silicon Valley and were advised by their venture capital backers to withdraw their money ASAP. That created a good old fashion bank run and led to the demise of the bank. SVB mismanaged several issues along the way but the run on their deposits is what ended them. The US government has moved quickly to ensure depositors are protected and in theory that should be sufficient to provide depositors confidence going forward.  

The US banking sector is much bigger than here in Australia but also much more fragmented. There are hundreds of medium-sized and thousands of smaller banks in the US. However, although the government has moved quickly to make depositors secure, we are talking about the same people who only months ago ransacked supermarket shelves of toilet paper during the Covid pandemic. So, let’s not pretend that people are going to be sensible and not panic when it comes to money in the bank. I believe the next move will be depositors moving their money out of small banks into the very largest to ensure the safety of their funds. Even if depositors are conceptually comfortable with the measures in place, the prospect that others might not be, or that the government may change the rules will push them to move to a big bank. No one wants to wake up to the news that their bank is at risk or that their funds are frozen. There really isn’t any incentive to keep their money in the 28th or the 37th biggest bank compared to having it in the 1st or 2nd largest bank. 

So, the largest banks will get even bigger as they win market share from smaller regional banks. I expect a wave of smaller banks to close and be taken over as they simply lose their client base to the biggest banks. Great for the big banks and their shareholders, terrible for the small banks and theirs. But it’s important to keep this dynamic in mind as the media will have no hesitation in printing headlines about the number of banks that ‘collapse’ along the way. It might be unnerving to see in the weeks and months ahead, but it doesn’t necessarily translate into another financial crisis. The depositors will move to a new bigger bank either by choice or when taken over and life will go on. The banks are not collapsing because of bad debts at this stage, it’s only because of a quirk that’s created a liquidity and confidence issue. In other words, at this early stage it doesn’t seem to me that these banks failing will create the negative economic consequences feared, and that is an extremely important distinction.  

So, while I do expect that there are other issues brewing that will negatively impact the economy, to me this banking issue isn’t likely one of them. That said, the spectre of unrealised bond losses such as those incurred by SVB will hang over many institutions from insurance companies to banks and pension funds and is yet to be fully understood by markets. I think the fear in this situation is more likely to create opportunities to buy the very biggest US banks such as JP Morgan at lower prices. Well-capitalised and well-managed businesses will benefit from the wave of new customer deposits and gain market share as the fragmented US banking sector consolidates rapidly.  

General Advice Disclaimer: This information is of a general nature only and may not be relevant to your particular circumstances. The circumstances of each investor are different, and you should seek advice from an investment adviser who can consider if the strategies and products are right for you. Historical performance is often not a reliable indicator of future performance. You should not rely solely on historical performance to make investment decisions.