Canadians should consider dividing their money between banks if needed
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 the 2008 financial crisis.
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, sheds light on what's causing the instability in the banking system and how it might affect Canadian financial institutions.
What's responsible for the current bank collapses in the US and Europe?
The bank collapses started with Silicon Valley Bank, which specializes in banking for technology companies. With the recent contraction in the tech sector, other forms of financing, such as venture capital, started to dry up, forcing firms to rely more on their bank deposits for day-to-day operations. Once too many depositors withdraw funds, a bank run becomes sell-fulfilling: by moving your money away from the bank, it becomes more unstable, and in turn, more people become worried and withdraw their money.
Sadly, these types of panics can spread, with Credit Suisse being the most important casualty. Whereas most large banks are healthy enough to absorb outflows, Credit Suisse was not in such a position.
Are we heading for a repeat of the 2008 financial crisis?
Although more banks may fail, today's conditions are different from the 2008 financial crisis. The collateral held by many of the banks that found themselves in crisis during that episode was opaque and tied to the US housing market. Now, much more collateral is in government debt, which is safer and much easier to value.
How likely is the instability in the banking system to affect Canadian financial institutions?
Canada has a very different banking system than the US. The US has many small regional banks, while a handful of large banks dominate Canada. In Canada's favour, larger banks tend to be where those who are scared move their money to not from. In addition, many large banks are viewed as too big to fail.
Although small, it is important to note that the instability probability is not zero. Therefore, Canadians should consider the Canada Deposit Insurance Corporation deposit protection limit and split their money between banks if needed.
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