Following 2008’s financial crisis, the US regulators revised their toolkit, encouraging banks to lean on supposedly sticky sources of cash. With “big banks” failing in 2023, the regulators have to rethink of the toolkits to prevent a broader banking meltdown.
After the financial crisis of 2008, new regulations were implemented in the USA with the intention of eliminating the need for bank bailouts. However, its greatest test to date has exposed severe flaws. Governments have had to act as lenders of last resort to avoid the recent banking sector turbulence from turning into a full-blown crisis. By utilizing public monies to bolster failing private organizations, they have exposed the enormous threat that bank failures continue to pose to taxpayers and the broader financial system.
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In the past fifteen years, it has been evident that lenders’ propensity to support themselves lavishly with volatile, short-term borrowing from financial investors has grown problematic. This has contributed to the collapse of financial giants such as Lehman Brothers and Northern Rock. As a result, regulators altered their toolset to encourage banks to rely on supposedly sticky sources of liquidity, such as the funds that people and businesses maintain in their accounts.
What is the scenario now?
The stabilization of the ecology has been accompanied with unexpected repercussions. Corporate and elite depositors have shown to be flighty. Technology-heavy customers of Silicon Valley Bank (SVB) attempted to withdraw $42 billion in a single day. In the final three months of 2022, Credit Suisse’s deposits decreased by more than one-third as worried wealth-management clients withdrew. In 2008, there was a widespread migration of capital from the lending industry. However, they may have replaced this issue with a dependency on corporate and private banking customers, who can also withdraw funds in minutes.
Regulators will reconsider their toolset, but earlier pest-control methods will not be effective this time. After the previous financial crisis, Basel laws mandated that banks maintain sufficient liquid assets to cover all of their wholesale funding, as though every cent could be needed at once. For corporate deposits that exceed national deposit guarantees, banks normally need to hold only 40% in liquid assets, or 10% if the depositor has a “high net worth.”
“I have argued for years that the biggest banks in the world are still too big to fail. This question is now beyond doubt,” said Neel Kashkari, president of the Federal Reserve Bank of Minneapolis.
US regulators had to adopt exceptional measures that compromised post-crisis regulations to prevent SVB’s failure from triggering a bigger financial catastrophe.
Are banks secured enough? What are experts saying?
Recent bank failures have led some legislators and regulators to argue that banking regulation should be tightened, despite the fact that existing regulations have been disregarded. Recent instability has given regulators pause, despite the fact that banks are more resilient than they were prior to the global financial crisis by key metrics.
Michael Barr, vice chair for supervision at the Federal Reserve, urged the US Senate banking committee that bank regulations must be reinforced. The Swiss government, for its part, stated that it would conduct a “comprehensive evaluation of the too-big-to-fail regulatory framework” and report its findings to parliament.
Sam Woods, the deputy governor for prudential regulation at the Bank of England, told UK legislators that there may be an issue as to whether banks are compelled to maintain sufficient cash on hand or readily available. “A striking feature of the Silicon Valley Bank run, though not so much of the Credit Suisse one, was the speed with which it took place,” he said Tuesday. “I do think we have to look back at these outflow rates … and ask what we have learned,” he added.
Some of this threatens the fundamental business model of banks. Lenders must set aside only a fraction of the funds deposited with them. The remainder is either lent out at higher interest rates or invested, as this is how large banks generate the majority of their profit. Any institution whose depositors wish to withdraw their funds simultaneously would be in jeopardy.
To completely eliminate the risk of a bank run, creditors would need to retain 100 percent of all deposits in cash or reserves at central banks. However, regulators do not view this outcome as desirable.
“We do not want to operate a zero-failure regime, because there would be some significant costs in terms of availability of lending to the economy,” Woods said. He commented that this trade-off is inherent in all regulations.
There are fewer extreme methods for making banks safer. Requiring bankers to support themselves with more equity and less debt would be one solution, according to John Vickers, who led the independent panel that reviewed UK banking policy following the 2008 financial crisis.
Was SVB’s collapse a financial crisis like 2007-2008?
While the repercussions of SVB’s failure are still being felt, experts agree that it differs significantly from the collapse of financial giants such as Bear Stearns and Lehman Brothers that sparked the 2007-2008 global financial crisis. In contrast to firms such as Lehman Brothers, SVB’s activity was concentrated in a single area and had little interactions with other banks.
“The SVB situation definitely has people worried but I don’t think it’s likely to turn into a Lehman type of situation, especially given how aggressively the Fed has intervened, including by promising to protect even uninsured deposits. I think any direct fallout is likely to become clear pretty quickly, although it’s certainly possible that there are other banks that are in a similar predicament due to the rise in interest rates.”
David Skeel
Professor of corporate law at the University of Pennsylvania Law School
Since the 2007-2008 financial crisis, financial regulation has also been substantially tightened. The reasonable course of action would be to increase these coverage percentages to 100 percent or something similar. But if regulators began requiring banks to back 100% of these deposits with liquid instruments rather than loans, the amount of cash they would be required to retain would leave them with little room to lend to the economy.
The convenience of online banking has made it simpler for users to withdraw cash, and social media exacerbates financial fear. It is evident that deposits might swiftly become hostile. A solution could be to comprehend their behavior, and be willing to lose the occasional sheep.
