Investors are having a panic about the banking sector due to the issues created by Silicon Valley Bank in the US and Credit Suisse in Switzerland.  Bank share prices have fallen sharply in the last month and many are concerned that we are on the precipice of another financial crisis led by the collapse of the banking sector.  The banking sector is different to other sectors in the way that it is financed and the importance to the rest of the economy.  Banks do a job that no-one else wants to do, they borrow money in the short-term (consumers want access to their deposits straight away) and lend over the long-term (consumers want 25 year mortgages).  If there are no deposits, then there are no loans and mortgages.

The sector has some similarities to other sectors in that in times of stress, weaker business models and management teams can lead to the fall of businesses.  If that happens in retail, you might notice some empty shops or a website has gone.  If it happens in banking, it creates panic across the sector.  Banking relies on confidence, which is to a degree being tested at present.  However, we would argue that it is very different now to that of 2008 and here are six reasons why.

Leverage and capital levels

In 2008, banks had very little capital buffers and too much leverage and have spent the last fifteen years building higher levels of capital. Most of the largest banks now have excess capital.

Asset quality

The other issue that banks had in the last crisis was the poor quality of assets that they held, that fell considerably, meaning banks went bankrupt when their assets fell below their liabilities. The asset mix that banks own now is more diverse and of far higher quality.

Today is a liquidity and solvency issue rather than a bankruptcy issue

Whilst neither are good issues to have, they are very different. In 2008, banks such as Lehman Brothers saw their assets fall so much in value that their liabilities exceeded their assets.  Banks liabilities include debts such as deposits and its assets include loans and mortgages.  If deposits are pulled from a bank, their liabilities fall but the valuation of their assets don’t.  The problem banks have is that their assets are generally leant out for years and can’t easily claim them back, so they fall into insolvency where they don’t have enough liquid assets to pay the liabilities.  If deposits stay with the bank, they should be fine.

Profitability

Credit Suisse has had profitability problems for years, partly due to poor management and partly due to negative interest rates in Switzerland. As interest rates have risen, it should improve the profitability of banks.

It is easier to move money now but harder to withdraw 

In 2007, Northern Rock went bust and people queued up outside branches to withdraw their money. One issue that the US bank SVB had, along with Credit Suisse, is that it is far easier now to move your money around.  If there is even a slight question mark over the safety of the bank you use, you can do an instant online transfer to another bank with your savings.  However, it is quite difficult to withdraw money as branches and ATMs disappear.  We therefore believe that the big ‘safe’ banks are going to get bigger and ‘safer’.

Regulatory environment

In 2008, banks such as Lehman Brothers were allowed to fail. Regulators have spent much of the last fifteen years ensuring that communications and oversight is more robust with banks and the standards that banks have to meet are much higher.  It is evident over the last two weeks how quickly regulators have reacted to the SVB and Credit Suisse issues that they are determined to do what they can to support the sector. 

There is undoubtedly a confidence issue hitting some banks at present, generally those that have been unprofitable and poorly run.  As per any other industry, there are poorly managed banks that will find this environment difficult.  The media has a role to play to not create panic in consumers and not spread gossip and lies about banks.  If confidence is lost in a bank and there is a flight of deposits, central banks can help to manage short-term liquidity mis-matches, however they can only help whilst the bank is a viable business.  However, this isn’t a problem for the whole sector.  In the week after the collapse of SVB in the US, Bank of America had $15bn of new customer deposits.  Deposits in SVB UK, now owned by HSBC, are now roughly back to where they were before SVB got into trouble.

Confidence is everything in banking.  That is why the Financial Services Compensation Scheme (FSCS) exists in the UK, to give confidence to consumers to deposit cash with banks, which creates loans and mortgages.  It is critical to the economy.  The large UK banks are in a good position; they are profitable, various sources of funding, large amounts of excess capital and we have no reason to believe that confidence should wane in any of them.

It can be worrying to see headlines about banks and that is what has created the fall in asset values over the last couple of weeks.  However, this isn’t a repeat of 2008.  It is a normal economic cycle to see businesses fail.  We need weaker businesses to fail to ensure capital is used correctly and efficiently; it just feels painful when you are going through it.

The operational performance of the assets we hold in portfolios at present is positive, despite the fall in asset prices.  The positive that we have seen in recent weeks is that bond prices have been rising, which has helped protect some value in the portfolios.  That is a different reaction to the last year, when bond prices fell with equity prices.  We are in the process of making a couple of changes to the portfolios and we are confident that we are well positioned.

If you want to understand our portfolios or how we combine financial planning with investment management, please get in touch with any of the team. Thanks for reading.