A series of continuous collapses. Why are banks facing a major crisis of confidence?

Over the past two weeks, the banking sector has been in a state of panic due to the derailment of banks due to the jump in interest rates, as major banks suffered a series of collapses, led by Silicon Valley Bank (SVB), Signature and Credit Suisse, which raised the question of the reasons that brought the banking sector to this situation.

A report in Swiss newspaper Le Temps attributed the banking sector to higher interest rates, a move taken by central banks in response to higher than expected inflation.

In theory, tightening monetary policy would benefit bank stocks, but contrary to expectations, a different scenario occurred in which customer confidence in banks was shaken by their irrational moves, but this does not necessarily mean a repeat of the 2008 financial crisis.

Over the years, there has been debate about what would happen if central banks raised interest rates and confiscated money that had emerged from the financial system.

Unprecedented deterioration

In the absence of signs of a repeat of the 2008 crisis, the outlook for financial equities and banks in particular was promising, and the collapse of the Silicon Valley Bank on March 11 accelerated the deterioration of banks' performances that changed the expected trajectory of financial stocks most connected to the real economy, and the policy of raising interest rates resulted in slowing economic activity, cautious investors, and complicated access to credit.

The rise in interest rates negatively affected banks, and the situation was made worse by the devaluation of US Treasuries, and as a result, the 16th bank in the United States in terms of the size of assets under management ($ 209 billion) suffered from the rush of customers to withdraw their deposits, and the most prominent victims of the shift in the path of investors, and without this toxic combination of factors, Silicon Valley Bank would not have failed, according to the newspaper.

Silicon Valley Bank's bankruptcy is the largest since the Washington Mutual failure in 2008, followed by investment bank Lehman Brothers and Bear Stearns, and more than 500 banks disappeared from the market between 2008 and 2015.

Amid panic in the U.S. regional banking sector, Silvergate and Signature collapsed because depositors are taking into account the domino effect on banks and the risk of mass bankruptcy.

In a bid to avoid disruptions in the global banking sector, Swiss authorities announced on Sunday that UBS had acquired its smaller rival Credit Suisse (Switzerland's second-largest bank), which recently collapsed, with a deal worth $ 3.24 billion.

Swiss President Alain Berset said the option was best to "restore confidence", while the central bank announced liquidity of up to $108 billion for both banks.

But Credit Suisse shares were down more than 62 percent a day after the deal, and UBS shares were down 8.8 percent.

Spectrum of the 2008 crisis

Everyone remembers the starting point of the 2008 crisis, which was the financial engineering of banks, and there has been a lot of talk about several institutions over the past two weeks, causing confusion in the minds of customers and creating pressure in the stock market.

Regardless of the impact of higher interest rates – which some observers believe may stop – it makes no sense that these banks' fate could be similar.

Europe's largest banking institutions, including Credit Suisse, have capital and liquidity ratios that protect depositors from turmoil, as well as guarantees as last resort, and a "too big to fail" mentality seems to have enabled banks to unconditional support.

Impact of interest rates

A year has passed since the Fed began raising interest rates and US banks began to collapse, and the British newspaper "The Guardian" reported that banks have been operating since 2008 under ultra-low interest rates and periodic injections of electronic cash from central banks, and this was actually seen as a temporary means in difficult circumstances in the wake of the collapse of Lehman Brothers, where cheap money and ample liquidity became a constant pillar of the markets.

Over the years, there has been debate about what would happen if central banks raised interest rates and confiscated money that had emerged from the financial system.

The measure, seen as necessary to curb inflation, has reduced housing bubbles and plunged stock prices, leaving banks with heavy losses in their holdings of government bonds.

The Guardian reports that the Bank of England has overcome the crisis faster compared to the Federal Reserve, as the Bank of England began raising interest rates in December 2021 and has now raised them 10 times in a row, and the European Central Bank waited until July last year, before deciding to increase borrowing costs for the first time in a decade, and continued to increase last week despite news that the banking crisis spread across the Atlantic to Credit Suisse.

The Fed will meet with the Bank of England this week to make interest rate decisions, and financial markets believe that in both cases the choice is either to make no change or to increase 0.25 points.

Given the delays involved, even a rate cut would be too late to prevent a decline in output in the coming months, but against the backdrop of low inflation, low global commodity prices and evidence of a growing financial crisis, any further policy tightening would be foolish.