What have we learned in the year since SVB triggered turmoil in the banking sector?

One year on from the banking sector turbulence that saw the collapse of regional lenders Silicon Valley Bank (SVB) and Signature Bank in the U.S., and, subsequently, the much larger Zurich-based Credit Suisse, policymakers are targeting tougher regulation to allay the risk and fears of another crisis.

What we’re watching:

Banks have always been vulnerable to quickly shifting sentiment among investors, depositors, and regulators. If left unchecked, fears among stakeholders that result in sudden and sharp deposit outflows (even if not a full-on run on a bank) can disrupt money flows, fuel market volatility, hurt bank profitability, and, on a macroeconomic level, curb consumer confidence and spending.

In the year since authorities in the U.S. and Switzerland stepped in to quell contagion risk after the collapse of SVB, Signature, and Credit Suisse, regulators remain acutely aware of the sector's sensitivities. At the time, most small and medium-size regional banks weren’t subject to the same requirements to report unrealized losses that larger lenders were. Some regulators have since taken, or are poised to take, steps to reinforce the resilience of the financial system—through tighter supervision and tougher regulation.

But regulation and supervision can only go so far. Banks, ultimately, are responsible for their own risk-management, and the recent troubles at New York Community Bancorp (NYCB) reflect just how sentiment-sensitive banks are. NYCB, a regional lender roughly half the size of SVB, saw its shares plunge after a surprise quarterly loss related to commercial real estate and disclosure of material weaknesses in its internal controls, resulting in customers pulling billions of dollars in deposits. (S&P Global Ratings withdrew its ‘BB+’ issuer credit rating on NYCB at the company's request on Feb. 14, 2023.)

What we think and why:

SVB’s troubles began because of a mismatch between short-term deposits and the bank’s holdings of longer-term financial instruments—a not uncommon position for a financial institution, but one that was exposed by the Federal Reserve’s campaign of aggressive interest-rate hikes. Because roughly 90% of SVB’s deposits exceeded the limit insured by the U.S. Federal Deposit Insurance Corp., it may have been more vulnerable than usual to a bank run.

SVB showed that social media has the potential to play a destabilizing role, depending on whether there’s credence to concerns raised on such platforms. Either way, liquidity runs are unlikely to be baseless. Rather, they express, aggressively, market and client concerns about a lender’s perceived flaws. Fundamentally, the banking volatility of March 2023 was the manifestation of a sharp rise in interest rates, combined with traditional banking risks, and the possibility of contagion.

In the U.S., this contagion was most acute because there were similar weaknesses across several banks, to various degrees. At the same time, authorities lacked resolution plans for these institutions, even as they turned out to be more systemically important than thought. Ultimately, the authorities stemmed this tide through extraordinary measures, including using their systemic risk exemption to pay out on uninsured deposits, and launching a specific bank-funding program (by the Fed) lending against securities at par value.

Credit Suisse’s troubles were self-contained rather than systemic, given the bank’s specific business model and pre-existing confidence problems—which, granted, were exacerbated by the loss of confidence in the U.S. Regulators stepped in, allowed the takeover of Credit Suisse by larger rival UBS without the need for shareholder approval of either bank, and at a price (roughly $3 billion) that was a fraction of the value of Credit Suisse’s assets.

Regulators appear to be united in their view that culpability for the failure of these banks lies squarely with management. Nevertheless, after a period of reflection, changes are afoot—in supervision and regulation. We don’t expect sweeping changes to the policy framework implemented in the wake of the Global Financial Crisis (GFC) of 2007-2008, but the U.S. market could see substantial changes to bank regulation and supervision, particularly for middle-ranking banks. Elsewhere, policymakers have highlighted areas of potential fine-tuning, a reinforcement of crisis management, and ensuring full implementation of existing standards.

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What Could Change

We see inevitable changes in regulatory standards, and bank supervision (how those standards are enforced). Supervisory change could be limited to the U.S. and Switzerland, although policymakers beyond their borders will doubtless reflect on whether they have anything to learn.

It’s possible that policymakers could agree on regulatory changes at a global level—but these can take years to execute. Changes are far quicker to agree on and deliver at country level. Notably, we see policy likely to evolve in the calibration of liquidity coverage ratios and interest-rate risk, and in crisis management.

In the U.S., policymakers have put forth proposals to increase the strength and resilience of the banking system—known as the Basel III endgame proposal and the global systemically important bank (GSIB) surcharge proposal—which modify capital requirements for large banks and detail how regulators plan to implement capital standards that the Basel Committee On Banking Supervision finalized in 2017 and 2019. The Fed and other agencies could make other changes in coming months, for example around liquidity-outflow assumptions, tougher liquidity rules for category III and IV banks, and the operational preparedness for banks to access contingent liquidity—perhaps even requiring banks to routinely borrow from the central bank’s “discount window,” which provides short-term funding for lenders, and a change to how to account for so-called held-to-maturity securities.

All told, S&P Global Ratings views tougher regulation on liquidity as a net positive for creditors. Although there are associated costs, liquidity is the critical risk for confidence-sensitive banks so it’s beneficial that a bank is ready to mobilize as much of its asset base as possible in a stress event—especially since a lack of such preparation was part of the issue in March of last year.

On the downside, this could result in less lending. As banks become more selective in lending to preserve their balance sheets, and look to comply with more stringent proposed regulation, entities such as small and medium-size businesses, as well as households, may find it harder to gain funding.

And tighter regulation for the banking sector won't resolve all systemic risks. As we’ve seen since the GFC, this could lead to more financing being done outside of the regulated financial sector, with a lesser degree of transparency and possible contagion risks for the economy. As always, regulations will have to strive for a balancing act.

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CreditWeek, Edition 20

Contributors: Giles Edwards and Stuart Plesser

Written by: Joe Maguire

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