I wrote at the end of March about the collapse of three banks; two in the US and one is Europe. Last weekend, we saw First Republic Bank taken over by JP Morgan in a merger that was rushed through over a weekend. It is not surprising to see more banks collapse after ones of similar size ran into trouble. Is the fact that it hasn’t gone away a cause of concern? Of course, it is never good to see banks fail but the issues here are clearly identifiable and nowhere near the scale of the credit crunch.
The sharp increases in interest rates by the Federal Reserve resulted in banks amassing paper losses. When interest rates were increased, the value of the bonds that the banks held fell in value. It didn’t matter that the bank intended to hold them to maturity and sell them at par (remember a bond is an interest only loan and you get the capital amount back at the end), it created a loss on their balance sheet.
This meant that First Republic needed recapitalising. If you hold more than the federally protected amount of $250,000 on deposit and you bank looks to raise more capital, would you leave your money there? Some companies held billions with these banks. Even though these were paper losses, you can’t risk it with that amount of money, hence the runs on the banks.
After the credit crunch recession, the US government enacted the Dodd-Frank Act 2010 which overhauled federal financial regulation. One of its provisions was to label a bank with over $50 billion in assets as “systemically important” and imposed stress tests and capital and liquidity requirements.
Of course, the banks weren’t happy with this enhanced regulation and capitalisation requirements, so they lobbied against it. In 2018, Trump rolled back some of the regulations. A bank now needed assets over $250 billion to be deemed a systemically important bank. This meant the stress tests and capital requirements for small and mid-tier banks were rolled back and they no longer required to be regulated in the same stringent way as the bigger banks.
This is another lesson that the financial industry needs strict regulation. If these banks were subject to more stringent stress testing and capitalisation requirements, it is less likely that we would be in the position we are in today.
While the US loosened its regulation for small and mid tier banks, the ECB has retained its tight requirements (Credit Suisse was not regulated by the ECB). From the banks point of view, this has resulted in higher costs for the bank and lower profitability. They complain and lobby against this tight regulation but to no avail. In February, the ECB announced the same levels of capital requirements for 2023 as in 2022.
While the banks will complain that their higher capitalisation requirements means lower returns for their shareholders, it does mean that its deposit holders are a lot more assured. We are simply not seeing the kind of worry and panic in the EU banking system that we are in the US.
There may be further consolidation of banks in the US. At time of writing (Thursday 04 May) PacWest is the latest bank to be in trouble with its share price down 40%. This has further to run in the US but the banking industry seem to be sorting it themselves and it doesn’t appear to be the same systematic failure that we had in 2008.
08 May 2023