Are we on the verge of another disastrous financial crisis?

In the month of March, the financial world woke up to the disturbing news of the collapse of three American banks. Quite predictably, there was a spillover impact some 4000 miles away from the US, in Credit Suisse bank in Zurich, Switzerland. This is precisely the profound way in which even slight tremors in the US Treasury market will have domino effect all around the world. And who knows this ugly truth better than banks and other financial institutions?

Their panic is not unfounded. They fear that a recession akin to 2008 housing bubble disaster is in the offing. Bank of America has emphatically underscored the criticality of ensuring smooth running of US Treasury market. So, what is happening in the US Treasury Market? Is another financial crisis brewing in the US that will have fatal implications globally?

It is comforting to know that this may not escalate to a global banking crisis. But what is worrying is that since 2015, on an average, at least 3 banks have collapsed in the US, and this doesn’t bode well for the global financial industry. Patterns are critical, in that they reflect underlying deeper financial woes that may have long-term repercussions and catastrophic implications worldwide. Did you know that a whopping 322 banks went under the bus during the apocalyptic 2008-2019 crisis?

The immediate effect of such collapses is that panicked depositors will demand rapid withdrawals leading to further deterioration of an already snowballing mishap, to the complete failure of bank valuations. Now, if one were to scrutinize if such a fatal banking sector crisis is underway, one must be well informed about the details of the credit cycle.

In the wake of 2008-2019 crisis, inordinately long and slow expansions of credit cycles were coupled with very low interest rates and substantial easing of regulatory policies, for small and medium banks. This was done to prevent a complete implosion of the entire payment ecosystem and to buy time to restore an economy in freefall. The pandemic induced limbo further exacerbated the situation. It also countered the policy normalization activities with ripple effects even a decade after the 2008 predicament. The net result during the successive years was the FED increased balance sheet value twice the normal and cut interests rates to an extremely low point, sometimes languishing between 0 to 25 basis points.

The most appalling of all financial chaos in the US was perhaps the Silicon Valley Bank collapse. With intuitive measures and prompt damage control, the FDIC or Federal Deposit Insurance Agency came to the fore to save the day. Their three-pronged damage control included:

1. The assets of all three failed banks- Silicon Valley Bank, Silvergate, Signature- were transferred safely to a larger bank.

2. Systematic and studied risk exception measures were undertaken to provide a safety net to all depositors. [However, shareholders were excluded.]

3. The third and the most effective solution was that the FED gave funding to banks that faced imminent threat of liquidity crisis.

These prudent measures restored calm in the chaotic market. How to avoid such a calamity in future, you may ask?

1. Our banks must become more resilient to credit cycles

2. Banks must abstain from risky ventures, especially during expansion phases and last but not the least,

3. Try their best to maintain robust liquidity levels to ameliorate any contingencies that may arise.

Today, our banks are better prepared and major banks in the US are well capitalized, stringently abiding by all regulations and compliances. When regulations are relaxed for smaller banks, they also run the risk of bankruptcy.

The three regional banks that collapsed in the US all belong to this category; each had its own idiosyncratic reason too for the unravelling. Banks play a crucial role in balancing inflation control and financial stability.

It is extremely difficult to predict when or if a financial crisis is imminent. Bank weaknesses are hard to evaluate and by the time the chink in the armor is identified, it is often too late. But one thing is clear, in a high debt-strapped world with consistently rising interest rates, it is a no brainer that some consequence is bound to arise down the line.

We will never be able to fully assess the magnitude of such accidents, the rapidity at which it will spread or if we can contain it before it snowballs into a major global catastrophe.