In a span of few days, Switzerland’s second-largest bank and one of the world’s most influential banks, Credit Suisse, announced its distress sale and was bought out by its domestic rival UBS for 3 billion Swiss francs ($3.25 billion) in what appeared to be a “shotgun wedding” and arranged marriage in equal parts. The government of Switzerland hurriedly brokered the deal so as to contain the crisis of confidence in Credit Suisse, which was facing withdrawals of around $10 billion last week as per reports, but also to stop the contagion to other banks.
This was a historic collapse for the 166-year-old bank. However, what appeared to be more worrisome was that this was the third major bank in line to see a fall of such a high magnitude in the last 10 days.
Is the world witnessing a banking crisis?
The collapse of major banks started with California-based Silicon Valley Bank (SVB) which was the first biggest bank in the United States to fall since 2008. Trying to understand the recent decline of banks, AMP chief economist Shane Oliver said although the failure of banks does not look like a return of the financial crisis, it does represent contagion risks.
Regional banks are being sold by the investors, in particular, over concerns that their balance sheets would resemble those of SVB finances.
Other parts of the financial market, which includes US tech stocks, have continued fairly well in the volatile weeks, indicating that few investors are hoping that the threat of a major banking crisis may subside.
However, it is clear that the speed at which SVB, Signature Bank, and then Credit Suisse collapsed, has filled the minds of bank investors and customers with fear of a major crisis in the offing.
Social media and quick dissemination of information have led to swift movement of share prices and led customers to quickly pull out their deposits.
In just 48 hours, SVB announced the sale of its bond portfolio at a loss and then its collapse.
In Credit Suisse’s case, Switzerland’s central bank pumped in an emergency loan last week which initially kept the bank afloat and soothed the market. However, by the weekend, the bank needed to be saved.
What are central banks doing to avert it?
A strategy was announced by various central banks to maintain the flow of money through the global economy to help avoid the credit crunch which was gripping markets during the financial crisis.
Headed by the US Federal Reserve, the initiative will make it possible for other central banks to obtain US dollars more easily which they can distribute to commercial banks in their respective countries.
The strategy has been designed so that it can ultimately flow through to borrowers who require access to credit for businesses, investments and mortgages.
The mechanism to ensure such a money flow is called a swap line which refers to agreements reached between two central banks for exchanging currencies. Till the end of April, daily and not weekly currency swaps will be offered by the Federal Reserve to ensure that adequate US dollars are with central banks in Canada, Britain, Japan, and Switzerland as well as the eurozone to operate.
The banks have designed the changes to avoid any credit crunch, a situation which leads to the tightening up of the global banking system and makes it tougher for businesses and consumers to get a loan.
The central bank of Australia has not been included in the initiative. It was indicated that the banking sector of Australia is robust despite the crisis looming in Europe and the United States.
WATCH | Credit Suisse shareholders take hit as UBS announces deal
What lies in future?
Even after Credit Suisse’s imminent fall, the European Central Bank (ECB) decided to hike interest rates by 50 basis points last week. On March 22, the US Fed will be unveiling its monetary policy review.
The Fed as well as other central banks have been extremely concerned about the financial system getting frozen and banks facing a deep financial crisis. Increasing interest rates in such a scenario can be seen as a risky step as it will further increase borrowing costs.
However, if the Fed takes a pause to fight against inflation, the problem may worsen even further. So the future will depend on how the Fed looks at the situation.
If the Fed finds the banking and financial system as essentially robust, then it can easily handle a few faltering banks by giving them liquidity support then it can take the decision to follow its path of monetary tightening and possibly increase interest rates by 25 basis points and not by 50 basis points.
If the Fed finds the financial system in grave danger, it may pause.
Whatever steps the Fed may take, more turmoil is likely to come in the days ahead, especially in terms of stock market behaviour.
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