Financial News Digest March 27: The Aftermath of Bank Collapse

Phew! March is finally coming to an end. There’s so much that happened this month - three major banks - Silvergate, SVB, and Signature Bank - have collapsed. What’s going on?

Quick Summaries of Bank Collapse

Banks ran out of money, then they failed.

Why?

The banks invested the excess funds in US Treasury Bonds during COVID time. Then, the Fed has hiked interest rates since last year, which has caused a steep drop in bond values.

Clients who fear bank collapses want their money back now, but banks are in a difficult position because the bonds they own are not valuable enough to pay the withdrawals. There is simply not enough money in the banks.

The banks tried to ask investors to put more money in to help, but that triggered another round of panic selling, entering a death spiral with more sell-offs. Silivergate Bank, SVB, and Signature Bank didn’t survive the liquidity stress last month, so they collapsed.

That summarizes what happened.

If you are interested in knowing more, check out our article, "6 Things to Know about the Recent Bank Collapse."

The Bank Crisis is still going on…

The banking crisis ain't done yet. With three banks already belly-up, Credit Suisse's got reason to sweat.

UBS took over Credit Suisse with the help of the Swiss government.

Following the collapse, Credit Suisse took the spotlight from the "collapsing play."

The second-largest Swiss bank started crumbling when it announced plans to borrow up to $54 billion to improve liquidity. Unfortunately, its biggest investor, the Saudi National Bank, refused the suggestion.

Then, Credit Suisse stock took a nosedive and never recovered.

As one of the 30 G-SIBs (Global Systemically Important Banks), Credit Suisse is so important that if it fails, it could shake the whole financial world. That’s the point when the Swiss Government stepped in to save the bank by assisting UBS to take over Credit Suisse by lending 109 billion to UBS and offering a guarantee of 100 billion francs from the Swiss National Bank.

And the takeover happened on March 19, 2023, with a cut-rate deal of 3.3 billion Swiss francs.

Credit Suisse and UBS have become the megabanks "too big to save"

If you think the drama is ending, regrettably, it isn’t, and that might be just the end of a chapter.

The two biggest Swiss banks have established an industrial colossus with more than $3 trillion in assets under management. This banking behemoth now exceeds the combined size of the second- and third-largest banks in the world, Bank of America and Citigroup, at twice the size of Switzerland's GDP.

The Credit Suisse-UBS merger has reconfigured the global finance scene. Questions about the bank's scale are simmering: what if this behemoth bank tanked? Who'd bail it out? The turmoil seems far from finished. That’s something worth our attention.

Are more banks joining the shipwreck?

Following the Credit Suisse-UBS merger, attention shifted to Deutsche Bank, Germany's largest bank.

For years, Deutsche Bank struggled with low profit margins, excessive costs, and reputational missteps that made investors keep a close eye on the bank. While the banking sector as a whole was having a rough go of it, Deutsche Bank was the first to be put under the spotlight.

Deutsche Bank’s share tumbled as much as 15% with investor concern about the stability of the banking system last week, with its Credit Default Swaps (CDS) price tripling on March 24, 2023.

Financial Term 101—Credit Default Swaps (CDS)

Credit Default Swaps are like life insurance of bank bonds. If the bank fails, you will be guaranteed to receive the borrowed amounts. If the CPS prices increase, that means investors are losing confidence in the banks and have a greater fear of bank failure, and they will pay more for "insurance".

The German Bank regained lost ground earlier this week after reassuring investors with a presentation of its diverse deposit base and the proportionate level of its exposure to U.S. commercial real estate. Since then, the stock price has steadied. It appears that the banking crisis has paused in this area.

The Knock-on Effect of the Rate Hike

Another major investor’s theme is the Fed’s rate hike.

On March 22, the US interest rate increased by 0.25% to a new 4.75-5% target range, which was less than the previous increase of 0.5% due to uncertainty after the bank collapse.

The Fed members now admit there's some doubt about the hawkish stance. Here are the Fed officials’ rate hike projections for the coming year:

• 1 Fed member thinks rates won't go up again this year;
• 10 members see just one more rate bump;
• 3 members foresee two additional rate increases;
• 3 members anticipate three additional rate hikes;
• 1 member anticipates four further rate increases.

To raise rates or not—depends on inflation, unemployment level, and banking stress

Rate hikes are now taking effect in curbing inflation, but far from the 2% target

With consecutive rate hikes, consumer prices reached 6% yearly in February, declining more than 3 percentage points from the June peak of 9.1%. However, inflation tripled the Federal Reserve's preferred 2% target.

With the most recent rate increase, the Fed demonstrated to the market its commitment to fighting inflation, notwithstanding the fragility of the banking sector. Curbing inflation is still on the Fed’s top list.

Tightening the credit environment may help fight inflation

Financial conditions have tightened since the March bank failures. Bond market risk rose in March to its highest level since 2009, showing that these assets have become less liquid in the market.

Consequently, banks may tighten the reins on business and personal loans to make sure they've got enough cash on hand to cover their customers' deposits, and this might actually help the Fed by bringing down demand and prices.

What should we expect in the coming quarter?

What we’re experiencing right now is the balancing act between three major economic factors: the stability of the banking system, inflation, and interest rates. And the following important economic indicators to keep an eye on in the next few months could have a big impact on the market landscape:

• The March 2023 CPI will be released on April 12. The data shows the US inflation rate, which has a great impact on the Fed’s interest rate decision.
• The next FOMC meeting will be held on May 3. You may find out what the Fed’s decision on the interest rate is.
• Some investors are shifting into a reserved investor sentiment: preparing for the recession by shifting their portfolios into recession-proof assets like cash, large-cap stocks, and gold.

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