Understand the 2023 Banking Crisis: A Simple Guide for Beginners

Do you want to learn about the 2023 banking crisis in a simple way? Read this blog post that explains the causes, effects, and lessons of the turmoil. #banking #crisis #finance

Understand the 2023 Banking Crisis: A Simple Guide for Beginners
Photo by Markus Winkler / Unsplash

If you are interested in learning about the 2023 banking turmoil, you might be interested in reading the "Report on the 2023 banking turmoil" by BCBS.

But you might find it too complex and technical to understand.

Don’t worry, I am here to help you.

Read my other posts here: Conventional Finance - FinFormed, Islamic Finance - FinFormed, Takaful - FinFormed, Career - FinFormed and Randow Writings - FinFormed

What is the 2023 banking crisis?

The 2023 banking crisis is the most significant system-wide banking stress since the Great Financial Crisis (GFC) in 2008-2009. It means that many banks around the world faced serious problems and some of them even failed or had to be rescued by the government or other banks. The banking turmoil started in March 2023 and lasted for several weeks. It affected the global economy and financial markets, causing volatility, uncertainty, and losses for many investors and businesses.

What caused the 2023 banking crisis?

The 2023 banking turmoil was caused by a combination of factors, including:

💡
The macro-financial backdrop: This refers to the big picture of the economy and finance. Before the turmoil, there were some challenges and risks that made the situation more difficult for banks.

For example, there was a lot of debt in the public and private sectors, interest rates were very low for a long time and then rose quickly, inflation was high, and there were geopolitical conflicts and supply disruptions.

These factors created pressure on banks’ profitability, asset quality, and funding.
💡
The non-bank financial intermediation (NBFI): This refers to the activities of financial institutions that are not banks, such as hedge funds, private equity funds, insurance companies, etc. NBFI grew significantly in the past decade and became more connected with banks.
This created more complexity and opacity in the financial system. Some NBFI activities were risky and unregulated, such as cryptoassets (digital currencies like Bitcoin), which had huge price swings and attracted a lot of speculation.
💡
The bank risk management practices and governance arrangements: This refers to how banks manage their risks and how they are supervised by their boards and regulators. The banking turmoil revealed that some banks had serious weaknesses in this area. For example, some banks grew too fast without having adequate controls and systems, some banks took too much risk without having enough capital and liquidity buffers, some banks had poor risk culture and did not listen to feedback or warnings from regulators, etc.

Let me give you some imaginary examples to illustrate these factors.

Imagine that you are a bank manager who wants to make more money for your bank. You have two options:

Option A is to lend money to safe borrowers who pay low interest rates but are unlikely to default;
Option B is to lend money to risky borrowers who pay high interest rates but are more likely to default.

Which option would you choose?

If you choose Option A, you are following a conservative strategy that is less profitable but also less risky. You are also following the Basel standards, which are global rules that require banks to have enough capital (money) and liquidity (cash) to cover their risks.

If you choose Option B, you are following an aggressive strategy that is more profitable but also more risky. You are also violating the Basel standards, which means that you are exposing your bank to potential losses that could exceed your capital and liquidity.

Now imagine that you have chosen Option B and lent money to many risky borrowers. Some of these borrowers are involved in cryptoassets, which are very volatile and unregulated.

One day, there is a sudden crash in the crypto market and many of your borrowers lose their money and cannot repay their loans.

At the same time, interest rates rise sharply because of inflation and geopolitical tensions. This means that your loans become less valuable and your funding costs increase.

You also face a deposit run, which means that many of your depositors withdraw their money from your bank because they lose confidence in your ability to repay them.

What would happen to your bank in this scenario?

Your bank would face a liquidity crisis, which means that you do not have enough cash to meet your obligations. You would try to borrow money from other sources, such as other banks or the central bank.

However, other banks might not want to lend you money because they think you are too risky or they have their own problems. The central bank might lend you money but only if you have good collateral (assets) that they can take if you do not repay them.

If you cannot borrow enough money from other sources, your bank will face a solvency crisis, which means that you do not have enough capital (money) to cover your losses.

You would try to raise capital from other sources, such as selling some of your assets or issuing new shares. However, you might not be able to sell your assets quickly or at a good price because the market is in turmoil. You might not be able to issue new shares because investors do not want to buy them or demand a high price.

If you cannot raise enough capital from other sources, your bank will face a failure, which means that you cannot continue to operate. You would have to close your bank and hand it over to the authorities, who would try to resolve it in an orderly way.

This could involve selling your bank to another bank, splitting your bank into a good bank and a bad bank, or liquidating your bank and paying back your creditors and depositors as much as possible.

This is what happened to some of the banks that were involved in the 2023 banking turmoil. Let me tell you their stories briefly.

  • Silicon Valley Bank (SVB): This was a US bank that specialized in lending to technology and life sciences companies. It grew very fast by attracting deposits from venture capital funds and technology firms. It invested these deposits mainly in long-term securities that paid high-interest rates. However, when interest rates rose in 2022, these securities lost value and SVB faced losses. SVB also faced a deposit run from its customers who were worried about its financial health and the outlook of the technology sector. SVB could not borrow enough money from other sources and failed on 10 March 2023.
  • Signature Bank of New York (SBNY): This was another US bank that focused on commercial lending and deposit gathering. It expanded its business by launching new initiatives, such as providing services to the private equity industry and the crypto industry. SBNY also faced a deposit run from its customers who were affected by the failure of another crypto-related bank (Silvergate Bank) and the failure of SVB. SBNY had poor risk management practices and controls and did not heed the warnings from regulators. SBNY could not borrow enough money from other sources and failed on 12 March 2023.
  • Credit Suisse (CS): This was a Swiss bank that was one of the largest banks in the world. It had various businesses, such as wealth management, investment banking, and asset management. It was involved in many scandals and losses over the years, such as the Archegos and Greensill failures in 2021. CS lost the confidence of its clients, market participants, rating agencies, and regulators. CS faced liquidity outflows from its wealth management customers who withdrew their money after hearing negative rumours about the bank. CS also faced difficulties in transacting with other market participants who demanded more collateral or pre-funding. CS could not regain market and client confidence and had to be rescued by another Swiss bank (UBS) on 19 March 2023.

What can we learn from the 2023 banking crisis?

The 2023 banking turmoil taught us some important lessons about banking and finance. Here are some of them:

  • Banks need to have strong risk management practices and governance arrangements.
  • They need to understand their risks, measure them, control them, and report them.
  • They need to have adequate capital and liquidity buffers to absorb losses and meet obligations.
  • They need to have good risk culture and listen to feedback from regulators.
  • Supervisors need to have strong and effective supervision of banks. They need to identify weaknesses in banks, take prompt actions, enforce rules, monitor changes, adapt approaches, and cooperate with other supervisors across borders.
  • Regulators need to have robust regulatory standards for banks. They need to implement global rules consistently, design and calibrate rules appropriately, balance regulation and supervision, reflect proportionality and scope, and review performance and impact.
  • Market participants need to have prudent market discipline for banks. They need to assess banks’ financial health, price risks accordingly, diversify exposures, avoid herd behaviour, and maintain liquidity buffers.
  • Customers need to have informed deposit insurance for banks. They need to know how much of their deposits are insured by the government or other schemes, how much are uninsured and subject to loss, how they can access their deposits in case of a bank failure or resolution, and how they can diversify their deposits across different banks.

I hope this blog post has helped you understand the 2023 banking turmoil better. If you have any questions or comments, please feel free to leave them below. Remember, finance doesn’t have to be complicated. With the right guidance and a bit of patience, anyone can understand it!

Disclaimer: The views expressed in this blog are not necessarily those of the blog writer and his affiliations and are for informational purposes only.

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