The near banking crisis of March 2023

The near banking crisis of March 2023

An analysis of the triggering factors and the deeper systemic causes

At the epicentre of the anxiety attack over a new banking crisis were Silicon Valley Bank (SVB) and Signature Bank in America, and Credit Suisse (CS) in Europe. The anxiety attack was triggered by the strong interest-rate hikes in Fed funds, causing a sharp rise in interest-rate levels everywhere. To what extent the scale and speed of these rate hikes were justified, or whether they may have opened up an era of stagflation, remains to be seen. In this place, the focus is on the impact on banks and the near banking crisis of the second and third week of March 2023.   

Rising interest rates means losses in the market value of securities such as US Trea­su­ries and other sovereign bonds. Since bonds are not accounted neither at face value nor their actual purchase price, but to their current market price (marked-to-market), and securities represent over a quarter of US bank assets, and about a fifth of European bank assets, the losses in the value of securities here and there resulted in balance-sheet imbalances, that is, equity slipping into the red.

Since the beginning of the Fed's policy of Quantitative Tighte­ning through interest rate hikes, and other central banks following suit, quite a few financial market actors had already begun to withdraw deposits from banks they con­si­dered vulnerable, or to sell off debt papers issued by these banks. As far as SVB is concerned, a decisive factor is seen in its special exposure to venture capital and start-up financing, that is, com­pa­nies that felt the impact of the tighter financial environ­ment more than others.

The relevant back­ground regarding CS included multi-billion losses from joint invest­ment-fund operations with Greensill Capital that went bust in 2021. In another case, a New York hedge fund manager was granted oversized loans that were lost. When a bank employee embezzled large sums from a Georgian billionaire, the bank denied liability. There were other such incidents that damaged the bank's reputation and caused clients to turn away. The creeping run on indi­vi­dual banks such as CS and SVB went largely unnoticed by the public for quite some time.

Attempts by the banks to raise fresh equity to offset the losses and outflows failed. This turned the creeping bank run into an accelerating run, becoming apparent when the Chairman of Saudi National Bank, with a 10% block of shares CS's largest share­holder, declared not to inject further capital into the Swiss bank. From that moment on, the banks con­cer­ned found them­selves in a liquidity crunch and a sol­ven­cy crisis.

And this in turn – in an attempt to nip any panic in the bud – finally prompted the swift trans­fer of Silicon Valley Bank and Signature Bank into the custody of the US Federal Depo­sit Insurance Corporation (FDIC) until suitable buyers would be found. As for CS, it was taken over by Union Bank of Switzerland (UBS), another mega bank, which itself had to be rescued in the 2008 banking crisis. The takeover of CS by UBS was organised and funded over the weekend of 18/19 March 2023 together with the Swiss National Bank, the government and further authorities concerned. The takeover makes for a banking behe­moth, representing a considerable cluster risk for Switzerland as an international financial hub.

The Financial Market Authority (FINMA) ordered that the entire AT-1 capital of Credit Suisse be written off. AT-1 capital is short for 'Additional Tier-1' capital, introduced in the wake of the great banking crisis from 2008 to prop up banking capital. AT-1 capital comes in the form of con­tin­­gent convertibles ('cocos'), a higher-yield hybrid of bonds (banking debt) forcibly convertible into common equity tier 1 capital if need be. In that sense, AT-1 bonds are an instrument of customer bail-in, which means holding cus­tomers liable for their banks – which they had to do in the CS case with a total loss. In contrast, owners of CS shares were paid out, even if at a low level. The AT-1 bonds' total write-off has caused some outrage, for common tier 1 equity (bank shares) is supposed to have senior liability, whereas AT-1 bonds were offered as subordinated liability. The damage is significant both financially and morally. Broken promises are like broken china.  

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Has a new sector-wide crisis of banking and finance thus been averted and is it busi­ness as usual again? There have always been financial and banking crises and will occur further on. The basic risks inherent in credit and investment cannot be regulated away or bureau­cra­tically supervised away. Overreaching attempts in this regard are counter-productive. However: it makes a big difference whether you have a money and banking system – such as a sovereign money system – that has a safe and stable money base and in which a crisis of a single bank or even of the entire banking sector may occur only in rare exceptional cases; or whether small and large crises are endemic and part of the banking and financial sector's business as usual.

The latter is precisely what has become the case since the money in public circulation consists to 90–98% of freely created bankmoney (aka 'deposit' money or book money). The entire system presents itself as a bank­money regime dominated by the banks and the book money they produce, which, so to say, is held hostage to the banks' balance sheets. Central banks and governments have become auxiliary bodies of the ban­king sector, always compelled to come to the banks' rescue whenever these threaten to fail.

The inherent instability of the bankmoney regime and the financial economy based on it has basically three causes.

Firstly, the bankmoney regime is based on credit-and-debt money, created when mone­tary credit is extended, and deleted when monetary credit is redeemed. (Monetary credit creates new money). As a result, there is only as much money in public circulation as there is debt to banks. If a bank's balance sheet gets into difficulties, the existence of the customers' book money is threatened as well. The false identity of money and credit fully exposes a nation's money to the risks of finance, rather than finance being built on a full base of safe and stable central-bank issued sovereign money. This also involves intermediary credit (using pre-existing money) by non-banks, including shadow banks, because, even though non-banks do not create money themselves, their activities are based on bankmoney.   

Secondly, the bankmoney regime operates as fractional reserve banking. It is based on only fractional holdings of central-bank base money in the form of cash and central-bank book money reserves. To cir­cu­late 100 units of bankmoney the banking sector operationally necessitates only a fraction of about 2–6% in cash and central-bank reserves. Such low coverage means that as soon as any uncertainty arises, a run on affected banks sets in and, due to the far-reaching business interdependencies in banking and finance, threatens to plunge them into a wider liquidity and solvency crisis, with dire con­se­quences for the real economy.

Thus, central banks and governments, meanwhile also bank customers, have to stand by to rescue banks time after time in order to save the bankmoney and thus keep the economy going. The central banks became anytime 'lenders of last resort' as well as 'bond dea­lers of last resort' for the banks, and the governments became 'bankmoney gua­ran­tors of last instance' and, if necessary, 'recapitalisers of banks' in trouble. Priva­te banks and their private bankmoney thus have acquired para-state status – a con­sti­tu­tional mon­stro­sity in view of the state's monetary sovereignty, which should actually exist accor­ding to prevailing legal understanding.

Third, there is 'too much finance', or more precisely, for about half a century ever more monetary and intermediary credit (i.e. bank­money, and actually too much of it) went into non-GDP finance. This covers, for example, secondary trading in shares, currency speculation, derivatives trading without real underlying, not least real-estate trading as a pure financial capital investment with no or just marginal increases in real use value. Too much non-GDP finance leads to asset price inflation – much to the delight of asset owners, whereas such non-GDP financial transactions do not contribute to funding real-econo­mic activity; and yet the recipients of financial income from non-GDP financial assets get full access to real-economic output. The over­shoot in non-GDP finance contributes to increased inequa­lity of income and wealth and is widely perceived as unfair. So as not to be mis­understood: Non-GDP finances helping build savings and equity are basically useful. It's just that too much of a good thing is bad. And bankmoney creation has a bias towards fuelling non-GDP finance, overstraining the economy's financial carrying capacity.

In view of the state of affairs, one will conclude: It's time for a change, a change con­cer­ning first and foremost the recomposition of the money supply. Safe-stock central-bank-issued sove­reign money will have to replace unstable and unsafe bankmoney – be it in the form of (vanishing) solid cash, or book money reserves (so far exclusively available to banks), and soon also in the form of digital tokens (Central Bank Digital Currency CBDC). If one feels full substitution overnight to be too much of a radical big bang, central banks and govern­ments at least owe it to themselves and to their states' monetary sovereignty to get central-bank-issued sovereign money into general public circulation in a gradual process as soon and as much as possible, thus over­coming the near-monopolistic position of bankmoney.