FrontierView’s outlook hasn’t changed, but risks persist, and direct exposure should be monitored
Banking troubles in the US and the eurozone do not change our base-case scenario for global growth, given the relatively low likelihood for a wider banking shock transmission and a subsequent crisis. While the crisis will result in more constrained lending by banks for several months, it will also mean slightly less monetary tightening by central banks, broadly balancing out the impact on major economies relative to our earlier projections for stronger interest rate hikes by central banks. Our GDP forecasts have accounted for tighter lending conditions and a small uptick in unemployment that will result, and recent developments do not necessitate an immediate change in our outlook. FrontierView will continue to monitor the situation closely and adjust the outlook accordingly. Executives should note, however, that some risks persist and should review their and their partners’ direct exposure. A surprise collapse of a commercial bank with a large and diversified consumer/business customer base would signal the beginning of a downside scenario, necessitating close monitoring of both the US and the eurozone banking systems.
Overview
- Silicon Valley Bank (SVB) filed for bankruptcy on March 17, following staggering deposit withdrawals of US$ 42 billion.
- The bank’s collapse was prompted by its overexposure to government bonds and the need to sell off assets in an attempt to sustain its operational capital, as depositors sought to withdraw deposits.
- SVB’s collapse has caused significant concerns regarding the sustainability of the US banking sector, especially among smaller regional banks, with shares in some instances, such as First Republic, seeing a sharp drop.
- In response to the ongoing shock, the US Federal Reserve announced it will implement a new lending facility, which will allow lenders to access lending for up to a year using bonds as collateral, with the latter being valued at face value.
- Credit Suisse, Switzerland’s second-biggest lender, saw a similar outflow of deposits, after its largest investor, Saudi National Bank, announced that it would no longer provide financial assistance.
- The emergency credit line of US$ 54 billion, provided by the Swiss National bank, failed to calm investors, resulting in UBS, Credit Suisse’s largest competitor, to agree to purchase the embattled bank for US$ 3.25 billion.
- European bank shares plunged on March 17 amid wider liquidity panic but have since seen a gradual recovery.
- Both SVB’s and Credit Suisse’s troubles come amid 10-year high interest rates and risks over additional tightening, as central banks struggle to contain inflation.
Our View
SVB’s failure has brought back painful memories of the 2008 financial crisis and spurred wider market panic about the financial sector’s liquidity. The bank’s overall exposure to the wider financial infrastructure has been relatively limited, however, as SVB was serving primarily the tech sector and particularly focused on start-ups. SVB’s bankruptcy, however, underlines the vulnerability of US banks’ overexposure to government securities and a potential panic-induced withdrawal of deposits, but the Fed’s lending facility package should alleviate some of these pressures and ensure that depositors have full access to deposits while minimizing the effect of rising bond yields. While the ongoing shock is reminiscent of 2008, the drivers behind the shock to the US banking system 15 years earlier were different: “bad loans,” not the sharp tightening in lending conditions. This is not to say that the risk of a wider financial contagion is low, and smaller and overexposed US banks can and will come under pressure. However, overall bank liquidity ratios remain relatively healthy. and the borrowing of more than US$ 150 billion by US financial institutions through the Fed’s discount window suggests that domestic banks are clearly seeking to address ongoing depositor concerns. Lending is also likely to weaken substantially, as banks seek to reduce risks, which in essence will represent a de facto monetary tightening. The Fed introduced another hike of 25 basis points at its last meeting on March 22, bringing its funds’ target range to 4.75–5.0%, but concerns over the banking system may put a break on its plans to introduce additional hikes. Recent messaging has also been much more cautious and indicates that US monetary authorities are likely to pursue a wait-and-see approach through the rest of 2023.
While SVB’s collapse has undoubtedly fed into concerns over Credit Suisse’s portfolio, the lender has been embroiled in a number of scandals that have significantly depressed investors’ confidence. Unlike SVB, however, Credit Suisse has not seen substantial issues with liquidity and its access to the Swiss National Bank’s credit line would have ensured that it could cover deposits; the UBS takeover should ease nerves regarding the European banking system. While European banking shares have taken a considerable hit, they have subsequently stabilized and seen a mild recovery. European banks’ direct exposure to SVB’s collapse is limited, and their smaller government securities portfolios should give them more resilience when it comes to similar shocks. Furthermore, a low non-performing-loan ratio and a high aggregate liquidity ratio of 162% in Q3 2022, well above the ECB’s 100% requirement, should reduce systemic risks. Additionally, the ECB’s current lending facilities and emergency mechanism should prevent a substantial shock stemming from a run on deposits or rising spreads in eurozone yield curves. Despite a relatively optimistic view, monetary authorities will proceed with caution, and additional ECB hikes remain unlikely. The impact on the eurozone’s GDP under this base case should be negligible, but risks will persist in the short term.
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