Waterloo finance researcher explains the current bank collapses in the US and Europe
The recent collapse of banks in the United States and this week’s intervention by the Swiss government to facilitate the takeover of banking giant Credit Suisse might have some worried about a repeat of 2008.
Dr. James R. Thompson, associate professor in the School of Accounting and Finance and co-director of the University of Waterloo’s Computing and Financial Management program, says that while it is not the same type of crisis, some of the results could well turn out to be the same.
“In 2008, some banks got in trouble because of shoddy collateral, like mortgage-backed securities, which at the time no one knew much about and were very opaque,” Thompson says. “Now, the collateral that’s being used for loans tend to be fairly reasonable. More of this collateral in the US are government securities, which are easy to value.”
Dr. James R. Thompson, associate professor in the School of Accounting and Finance and co-director of the University of Waterloo’s Computing and Financial Management program.
But while the underlying conditions are quite different, “it doesn’t really matter,” Thompson continues. “If people decide they’re going to run a bank, the bank is going to get run, and the bank can’t do anything about it without government assistance or another bank taking them over.”
Although Thompson says the system is fundamentally healthier than in 2008, it does not guarantee the financial system will get through the current phase of instability without more bank failures.
Silicon Valley Bank (SVB), which was among the first to collapse in recent weeks, primarily served tech companies and more specifically venture-finance tech companies. Because of the recent tech downturn, Thompson explains, venture capital funding started to dry up. A natural reaction for such companies when they are not getting as much funding is to start drawing on deposits at their bank.
“What we saw was SVB simply having more of their customers taking money out. That feeds on itself. If everyone knows everyone else is taking their money out, it is easy to think, well, I better get there quickly in case there’s nothing left later.”
Over 90 per cent of the deposits held at SVB were uninsured, since US regulators insure deposits up to $250,000 and many of the bank’s customers had much more than that in accounts. When the bank collapsed, panicked companies and individuals were left wondering if it would mean the end for their businesses. A few days after the collapse the US Federal Deposit Insurance Corporation (FDIC) stepped in and blanket-insured all deposits, overriding the $250,000 limit for SBV depositors.
“Last weekend was a very tight weekend for many tech companies as they didn’t know how they were going to make payroll,” Thompson says. “And the following week, if they didn’t have access to enough of their money in SVB, that would have had serious consequences.”
The Tannery Building in downtown Kitchener is a hub for tech companies in the Waterloo Region. Local tech companies were caught up in the recent collapse of the Silicon Valley Bank.
Canadian companies, including many organizations in the Waterloo tech ecosystem, were also affected by the SVB collapse. “Our exposure in the Waterloo region would have been abnormally high for a Canadian city because of our tech community,” Thompson continues. The Canadian government did the same thing as in the US to guarantee any Canadian deposits held with SVB.”
Following the collapse of SVB and a few other US banks, instability in the banking system spread to Europe. In particular, Credit Suisse, among the largest and most important banks in the world, needed to be rescued by a sale to another Swiss bank, facilitated by the Swiss government.
“A failure of one of these banks that are included as a ‘systemically important financial institution’ could be catastrophic,” Thompson says. “They have too many connections to the rest of the financial system globally.”
But Thompson also points out that the issues with Credit Suisse were not altogether surprising, as the bank has in recent years been exposed to the failure of a large hedge fund and “the outflow of deposits from Credit Suisse really started last year.”
“In the last week, the run on the bank has picked up substantially, and they were unfortunately a weak link. It is quite a big deal, because Credit Suisse is such an important part of the global banking system. The results this past weekend was a guarantee from the Swiss Central Bank and their financial regulator, plus a buyout from fellow Swiss bank UBS.”
Asked what Canadians can do considering ongoing instability in the banking system, Thompson provides reassurances that large Canadian banks are generally stable and diversified, and so it is unlikely any Canadian banks would collapse.
Thompson points out that Canadian deposits are insured up to $100,000, and that the safe thing to do is to have multiple accounts at different banks if one exceeds that limit.
“It’s generally something that Canadians don’t think about very often because we think our banking system is so sound. But it makes sense to at least keep yourself protected just on that very small chance that things could go south here in Canada.”
