As banks and financial markets reel from the Silicon Valley fallout contagion looks inevitable
The past 10 days have shaken banks across the world and will put a dent in economic confidence that was already reeling from interest rates hikes, inflation and the fallout from the war in Ukraine.
To some, the collapse of Silicon Valley Bank carried eerie echoes of the global financial crisis when Bear Stearns and Lehman Brothers went under. The mid-sized US lender’s demise this time toppled two other US banks, Signature and First Republic, and forced the Swiss government to come to the aid of embattled Credit Suisse.
Bank of Ireland, AIB and Permanent TSB shares have taken a beating, too, amplifying the parallels to 2008 and the St Patrick’s Day massacre that holed Anglo Irish Bank below its waterline and silenced the roar of the Celtic Tiger.
After all, if a butterfly’s wings in far off in California can have the gnomes of Zurich shaking in their boots, what’s to stop the reverberations from pulsing through Dublin?
In just four trading sessions until Wednesday, Irish bank stocks shed about €4bn in value, hitting the State’s shareholding in AIB and PTSB for €1.25bn.
Shares recovered somewhat on Thursday and Friday after the mighty Swiss National Bank (SNB) provided emergency lending to Credit Suisse. But such intervention is not really a substitute for restoring confidence longer term.
The half a percentage point interest rate hike by the European Central Bank on Thursday probably helped too, signalling that policymakers believe eurozone banks can cope with tightening monetary conditions.
While nothing has changed fundamentally in the Irish banking sector, there is a sense that the trouble of the last week is unhelpful at the margins, where sentiment can be a decisive factor.
The 2022 results and 2023 outlooks from AIB and Bank of Ireland earlier this month supported a generally bullish tone around Irish banks. Promises of more than €700m in dividends and share buybacks helped, too.
The ECB has been warning banks about preserving capital to deal with bad loans in the event of a downturn and could decide to tell the Irish banks to be a little less generous when giving cash to shareholders.
However, an outright ban on dividends and buybacks, as was the case at the onset of the pandemic, is considered unlikely.
But how did this all start? How did we move so quickly from rude health to fear of contagion?
Silicon Valley Bank, the banker for California’s tech sector, put itself on the wrong side of interest rate hikes by taking big, lumpy deposits from its venture capital backed start-up customers and putting them into fixed income securities.
When those bonds lost value due to interest rates going up, SVB had trouble fulfilling deposit withdrawals and tried to raise new capital. This spooked customers, who rushed to get their money out, prompting US regulators to step in with a deposit guarantee and emergency funding.
Other banks, like Signature in New York and First Republic in San Francisco, ran into trouble, but quick action by the authorities helped stop widespread bank runs.
To get a sense of the scale, US Federal Reserve emergency lending to banks in the last week was greater than during the “Lehman moment” in 2008 when the entire financial system was crashing.
These problems likely to become clear over months, not hours or days
Nonetheless, panic spread across the Atlantic to perennially troubled Credit Suisse, which disclosed problems with its internal controls on Tuesday, leading to a chain of events that ended with the SNB stepping in with a funding line for the global investment bank.
In the middle of all this, Christine Lagarde announced an expected 0.5pc increase in ECB rates, signalling that the bank remained focused on fighting inflation rather than succumbing to worries in the financial markets.
“The larger hike sends a clear signal of confidence in the strength of the European banking sector. the narrative of fragility in the global banking sector will not dissipate overnight. The ECB has stressed that it will be monitoring the situation closely,” said Matthew Ryan, head of market strategy at Ebury.
The health of European banks has significantly improved in the last decade, which should contain any spillover effects, according to a report from Allianz.
Allianz and ECB data showed that Irish banks are among the least exposed to domestic government debt securities, so are not going to get tripped up by the same problems as SVB.
But after more than a week of massive volatility on the markets that fear will inevitably make the jump into the real economy.
Fears of a recession in Europe had waned recently, although the concern now is that shaken banks will shy away from risk and lend less.
That in itself could stoke a downturn.
Asset manager Amundi put its finger on “reassessment of recessionary risks” as an underlying factor in the rapid plunge in shares.
“The thing to focus on is not risk of rolling bank runs, but the impact of this crisis on broad lending conditions and the deeper structural weaknesses among smaller banks (especially with respect to commercial property),” said Dario Perkins, managing director of independent research firm TS Lombard in a tweet on Thursday.
“These problems are likely to become clear over months, not hours or days.”