Financial markets on edge as confidence in banks erodes: What you need to know

Global financial markets are in their worst state of panic since 2008

Global financial markets are in their worst state of panic since 2008, when cascading bank failures in the United States and Europe caused credit markets to seize, triggering what came to be known as the Great Recession.

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Things aren’t that bad this time. But they aren’t good either. Here’s what you need to know:

  • U.S. President Joe Biden addressed the nation on March 13, stating he will do “whatever is needed” to protect bank deposits after three mid-sized American banks failed in a matter of days.
  • North American stock markets were uneasy at the open after rocky trading in Europe. The main U.S. exchanges were little changed, a positive all things considered. The S&P/TSX composite index was down about one per cent at midday in Toronto because banks rank among Canada’s biggest publicly traded companies.
  • The U.S. Federal Reserve and the Treasury Department scrambled over the weekend to erect financial backstops that they said would protect depositors of California-based Silicon Valley Bank and New York-based Signature Bank, which were closed by state regulators on March 10 and March 12, respectively.
  • In the United Kingdom, authorities seized the British operations of SVB over the weekend and sold them to HSBC Holdings PLC for the equivalent of about US$1.
  • Canada’s banking regulator took over the Canadian operations of SVB on March 13, the first such action since OSFI wound up the Canadian operations of Germany’s Maple Bank GmbH in 2016.

Backstory

California’s banking regulator closed SVB Financial Group’s Silicon Valley Bank (SVB) on March 10 and asked federal authorities to sell the assets amid a run on the financial institution’s deposits. It was the second-biggest bank failure in U.S. history and stirred memories of the events that preceded the Great Recession in 2008 and 2009.

SVB wasn’t a typical bank. It was formed in the early 1980s in Santa Clara and quickly became the bank of choice for the region’s burgeoning technology industry, boasting that it banked “nearly half” of U.S. startups that had received funding from venture capitalists, and that 44 per cent of venture-backed technology and health-care companies that went public in 2022 were SVB clients.

Tech was a good place to be for much of the past couple of decades. But it also meant that SVB had a lot of eggs in one basket. As inflation and interest rates soared last year, investors grew less willing to get behind companies that were putting growth ahead of profits, causing a chill among a set of companies that hadn’t had to work very hard to raise money during an extended period of ultra-low interest rates. That meant SVB didn’t have as much money coming in.

Higher interest rates squeezed SVB from the other side of its balance sheet, too. Its clients were so flush with cash that SVB couldn’t deploy all their deposits by way of new loans, which is typically the way a bank makes money. Instead, it used its excess deposits to buy bonds, which is also standard procedure for financial institutions. But those bonds steadily dropped in value as interest rates rose because there was less demand for older securities that came with lower yields.

Eventually, depositors grew nervous about the health of SVB’s balance sheet and started a run on its assets last week. That’s when regulators shut it down.

In the aftermath, some commentators dismissed comparisons to the 2008-09 financial crisis, given SVB’s troubles are related to mistakes by management and its overexposure to a single industry. However, regulators in New York state on March 12 closed Signature Bank amid signs of a run on its deposits. It was the third U.S. regional bank to collapse in five days, following SVB and Silvergate Capital Corp.

Both Signature and Silvergate were exposed to FTX, the cryptocurrency exchange started by Sam Bankman-Fried, who faces criminal charges over the implosion of his company.

Why the fuss over a few mid-tier banks?

There’s a general uneasiness in financial markets over whether the global economy can handle the sharp increase in interest rates orchestrated by the Fed and other central banks over the past year. Labour markets in the U.S., Canada and elsewhere have held up surprisingly well so far, but inflation also remains high, and history suggests the only antidote for runaway inflation is a painful economic downturn.

Fed chair Jerome Powell shook traders on March 7 when he said better-than-expected economic data meant he would have to keep raising interest rates to offset inflationary pressure. Previously, he had indicated that he thought the worst was over. The zigzag caused some investors to lose confidence in the central banks’ ability to snuff out inflation without causing a recession. In other words, plenty of people were waiting for another shoe to drop and are now betting SVB was it.

Even if the negative takes on SVB are wrong, there’s no denying the bank’s troubles herald a difficult period for lenders. Bigger banks with more diverse sources of revenue face little risk of collapsing, even if there’s a recession. But many will be caught in the same jam that squeezed SVB: less money coming in, while assets on their balance sheets deteriorate in value. Most big banks should be profitable enough to survive, but those profits will shrink for a period of time. Smaller lenders that are overly dependent on single industries or businesses might not be.

Washington was unwilling to take its chances on the optimistic scenario. In a series of extraordinary actions that brought back back memories of the 2008-09 financial crisis, the Fed and the Biden administration extended rules that were put in place to govern too-big-to-fail banks to cover smaller SVB and Signature, declaring that depositors would be “fully” protected.

What about Canada?

Canada’s federal banking regulator took control of SVB’s Canadian operations over the weekend, ending some of the unease over what might become of deposits that local technology companies had left with the Toronto-based branch.

Peter Routledge, the superintendent of financial institutions, stressed that no individual Canadians banked with SVB, so any fallout will be limited to technology companies and venture-capital funds. According to filings with OSFI, SVB had a loan book totalling $435 million in Canada and reported $864 million in total assets here as of the end of 2022. The country’s biggest banks can easily fill the gap.

Still, Canada’s tech entrepreneurs are uneasy. They have long complained that the stinginess of the country’s risk-averse banks was a barrier to Canada taking full advantage of the historic shift to a digital economy and greener sources of energy. Many welcomed SVB’s arrival in 2019 as both a new source of lending and a competitive jolt to Canadian lenders.

“While there is an immediate impact on Canadian companies that deal with SVB, the longer-term impact is the loss of a globally competitive and technology-company focused banking service,” Jim Hinton, a patent lawyer who works with many technology companies, said in an email. “SVB forced Canadian banks to be more competitive and savvier when providing services and understanding the needs of technology companies.”

It might be the wrong moment to determine whether Canada’s big banks will provide the kind of support that tech startups enjoyed from SVB going forward. Their stocks were all trading lower on March 13, dragging the S&P/TSX composite index down with them.

• Email: kcarmichael@postmedia.com | Twitter: carmichaelkevin