So, US Banks Collapse, What Next?!
For nearly a century, banking in the US has always had an implicit and partial government backstop. However, last weekend, the US government made it, suddenly and unexpectedly, rather explicit and open ended.
This is a very big change for the country, for banking and for us all.
The aftershocks of the Silicon Valley Bank collapse are still reverberating and will continue for some time with, as Credit Suisse just demonstrated, unpredictable twists and turns still very possible.
After all, if the 16th largest bank in the country and one that services some of the richest and most sophisticated clients, corporations and industries can't manage interest rate risk and deposit outflows, then it hardly inspires confidence in the sector as a whole.
But we should nonetheless shift our focus away from the car crash aspect of individual banks and instead to the next struggle over the banking system as a whole.
The easy conclusion and near certainty is that banking in the US will never be the same. But how it changes is quite important to understand. There are a few likely outcomes that we can point to with at least some confidence.
Here are 5:
More size.
More regulation.
More shadow banking.
Less lending.
Less growth (& less trust).
All of these are significant, highly interrelated and mostly negative outcomes whether you are a company, a banking customer or just someone desperately hoping to talk to a live human at your bank of choice.
To take each in turn:
On the first point, everyone has just realized that even (large) regional banks are vulnerable to a) stupid decisions b) higher interest rates and c) bank runs.
Despite the fact that all of the country's deposits are now effectively underwritten this will not change the facts that many consumer and corporate actors have received a powerful scare and will now change their behavior as a result.
In other words, thanks to the SVB mismanagment, all over the country people and corporations are now doing what they should have arguably done before:
Made sure their funds and accounts are below the FDIC limit (see next story).
Open new bank account(s) at new bank(s) to hedge their exposure at their main institution.
Generally looking into who they bank with and why and whether this institution is being publicly discussed as "the next SVB" in any major news organization or online.
This is ultimate: well the horse has already left the barn example. It would be pretty funny if it were not so sad and telling about how humans operate.
We only do the thing we should have done when it is too late or no longer important to be doing it. We have all been there....
There is a common theme to these actions, however: the vast majority of new accounts, new business and new money will be at big banks. In particular, Wells Fargo, Bank of America, JP Morgan and Citibank will likely see huge inflows of deposits
Bank of America has apparently already received over $15 billion in new deposits in the week after SVB's collapse. And despite the fact that all US deposits are now underwritten, that is just the start of this trend.
Big (banking) is very much back in favor.
Everyone is going to hedge their bank account and the vast majority of those backup safety plans are going to be at the largest, most dependable and most regulated institutions.
Second, no one wants to be a (more) highly regulated Systemically Important Financial Institution (or SIFI) until they suddenly do.
The reason for that is SIFIs used to be more regulated. Now the reason that everyone wants to be a SIFI is, ironically, they are more regulated!
In particular, being regulated means that you are forced to hold onto more capital. This is a major drag most of the time because:
More regulation -> more capital -> fewer loans which -> less profits.
However, suddenly:
More regulation -> more capital -> greater safety -> more accounts -> more funds -> more profits.
File under: things we did not expect to be writing at the start of the year.
The new state backed guarantees have effectively swept all of the US banking sector into the same bucket as the largest, most systemically important financial institutions.
It will also lead, very quickly, to the quid pro quo of that sweeping change:
More regulation of the banking sector, big and small, is coming.
The entire SVB tragedy has demonstrated clearly that there are still real risks and issues with our banking sector despite, well, a lot of regulation. That is actually a problem and the fault of regulators, not the banks.
Read that again.
It is telling that there is never the same level of scrutiny applied to (failed) government regulation as there is to bad behavior in corporate offices. The answer is always more regulation and more powers for the same agencies that just failed.
Nice work if you can get it.
However, all of this is academic. No matter government errors and the fact that more regulation has significant downsides won't change a thing. The US government is going to seize the opportunity provided by the popular fear and anger, the banking sector's desperation and public anxiety over bank runs to re-regulate an already heavily regulated sector.
This increase in regulation will, in turn, have several predictable events. Starting with.....
Third, the flip side of more regulation of formal banks is more shadow banking.
Shadow banking is very simple: when you regulate banking strongly, the banking sector as a whole lends less money because it is forced to hold more capital and spend more in compliance.
Some of that lending is simply lost. But some of that lending activity simply moves to other, non-bank institutions. These could be asset managers, private equity firms or hedge funds. For people desperate to borrow money, money tends to find a way to them.
So, you can feel secure in knowing that while the regulators and politicians stand up there and talk about how they are making the financial system more secure with these upcoming changes to the sector that may very well be true.
But it will be equally true that they will be sending some of that "risk" scurrying into the shadows where it will still be, well, risky.
Thus continues the forever game of whack-a-mole that has been played by governments and lenders since, quite literally, the start of recorded history. As is commonly said in banking circles, the first day of banking likely coincided with the first bad loan which was quickly followed by the first banking regulator.
This understandably frustrates bankers quite a bit.
All in all, however, this more regulation/more shadow nexus will lead to the next consequence:
Fourth, there will be less lending.
It isn't getting a ton of press now - though it will - but the reality for many Americans and American corporations is that getting a loan going forward is going to be more difficult.
This was the case after the Great Financial Crisis when getting a mortgage went from too-easy to too-painful in a snap of the fingers.
This will now happen with all manner of lending. The process will become more onerous, more time consuming and for a marginal benefit at best. After all, Dodd Frank was 800 pages of careful litigation and yet a major US bank just collapsed because of something as simple as rising interest rates.
Anyway, less lending and less credit growth will be a feature of the economy in good times and bad going forward. And do keep in mind that, in the immediate, consumers and businesses will now be confronted with a nasty tandem: higher interest rates and higher capital requirements.
No fun.
Fifth and finally, there will be less economic growth.
All of the above sounds necessary right now. But it comes with real consequences: less access to credit means lower economic growth.
And not just that. This banking crisis is really another (the final?!?) nail in the coffin of the low interest rate regime and easy money era we have all enjoyed for the better part of a decade and a half after the Great Financial Crisis.
That also isn't appreciated right now during the tidal wave of op-eds calling for more banking regulation but less economic growth is a tough environment to help the poor, to help minorities and especially, to help small businesses.
That less growth won't just come from less lending either. It will also come from less trust.
As we said in our introduction, the image of worried Americans lining up in front of their banks in some of the richest cities in the country will not be forgotten soon. In fact, it will only reinforce the drift to a less risk taking, less trusting and more careful behavior.
A warp speed bank run driven by social media chatter and mobile banking apps will mean that everyone is subconsciously aware of how quick things can change.
There are some positives there but there are also lots of negatives. In an era where you worry about your bank and you can get 4-5% from a Treasury Bill or US government bond you have alternatives to riskier forms of investment.
That is likely a very different, less dynamic and less trusting America than we have experienced in the last 10-15 years.
In the vein of building some trust, let us turn to a US government institution that works well, has a near flawless track record and is suddenly getting its 15 minutes of attention in the regulatory limelight....
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