7 Key Lessons for Investors from the 2023 Banking Sector Turmoil

7 Key Lessons for Investors

from the 2023 Banking Sector Turmoil

Stress always returns to financial markets — but you can be prepared

The content of this post does not constitute financial or investment advice. It is intended for information and education purposes only.

This is a published article on Medium where you can read the full version

For a couple of months last year, beginning in March, the financial world kind of held its breath. Not because of geopolitical events this time, but because for a brief period, some people were wondering whether we would see a repeat of 2008–2009. That did not happen, as the crisis was contained to the regional banking sector this time. There was no contagion and potential financial stability concerns were addressed swiftly. But its very occurrence brought back some painful memories, once again raising questions about adequate risk management practices and regulatory oversight, and highlighted some key takeaways for the individual investor.

A short recap — what happened in 2023?

At the beginning of March 2023, the holding company of Silvergate Bank released a press statement saying that, as a result of recent developments including in the industry and the regulatory space, it had decided to shut down. The bank had been a major lender to cryptocurrency companies that had grown rapidly in the late 2010s and by the end of 2022, about 90% of the bank’s deposits were tied to crypto, and out of that, $1bn were linked to FTX’s founder and CEO Samuel Bankman-Fried. After FTX went bankrupt and major fraud by the company and its executives was exposed, Silvergate experienced a bank run, with deposit withdrawal requests exceeding $8bn — which it did not have on hand.

To cover the withdrawals, the bank had to liquidate holdings from its securities portfolio, which consisted mostly of mortgage-backed securities (MBS) and US government bonds. However, due to the impact of interest rate hikes by the Fed that had started in early 2022 (after the inflation shock following the Russian invasion of Ukraine and the economic consequences of the pandemic and the policy measures related to it), these securities had to be sold at a significant loss for the bank as they had dropped in value due to their interest-rate sensitivity. Despite stating that it was solvent in Q4–22, the bank needed to keep selling bonds and realizing losses until March 2023 to meet liquidity requirements, which diminished its capital position. On March 8th, it announced its voluntary liquidation and reimbursement of depositor funds.

Next came perhaps the ‘poster child’ for this regional banking crisis — Silicon Valley Bank (SVB). It was a 40-year-old financial institution, heavily focused on serving the tech sector: almost 50% of US venture-capital-backed tech and healthcare firms were financed by SVB. The bank was also providing personal loans and mortgages to individuals who were tech entrepreneurs. After the pandemic started, SVB experienced a considerable growth in deposits. It sought to increase its investment returns on the additional funds it had attracted by purchasing long-term Treasury bonds.

Similar to Silvergate, that portfolio (which was not properly hedged against interest rate risk in its held-to-maturity segment) was hit by substantial losses as rates rose, which eventually had to be realized as cash was needed to meet withdrawal requirements and securities were sold. Despite efforts to calm depositors and investors, major venture capital firms kept withdrawing funds, leaving SVB with a negative cash balance. Shares plunged and a trading halt had to be put in place. On March 10th, the bank was put under FDIC receivership due to inadequate liquidity and insolvency.

Two days later, Signature Bank collapsed. By now, you probably know the pattern: expansion due to the growth of a particular sector (in this case, once again — crypto clients); then a deposit run after the collapse of this sector and loss of investor confidence. On March 12th, it was closed by the New York State Department of Financial Services (NYSDFS) as it was losing deposits so fast that it was forced to ask the Federal Home Loan Bank (FHLB) of New York for money twice within 90 minutes. The NYSDFS stated that the bank’s growth had outpaced the development of its risk control framework.

But what was perhaps the biggest surprise of last year’s banking turmoil, was the collapse of a bank deemed ‘too big to fail’ — Credit Suisse, Switzerland’s second-largest lender with a 150-year-long history and among the biggest banks in the world. Since the Global Financial Crisis, Credit Suisse has been on a downward spiral — underperforming investment banking unit, management scandals, allegations of fraudulent marking of trades, conspiracy to commit tax fraud in the US, criminal investigations related to the Malaysian sovereign wealth fund (1MDB), spy scandals, etc.

So, even though it takes a lot to take down a global systemically important bank (GSIB) like CS, it is perhaps not a surprise how quickly depositor and investor confidence in it evaporated in March 2023. At the point when it was collapsing, the share prices of banks around the world had been affected by the regional bank failures in the US. In the 2 weeks to March 18th, the S&P Banks index had declined by 22%. The concerns were spreading over the entire sector about the negative impacts of the rate hikes. When the Saudi National Bank (CS’s biggest shareholder) could not provide further investment due to regulatory constraints (and other reasons), announcing this in a very public statement, to the rest of the world it appeared as if this was a sign about how bad things were. And investors started to panic en masse — CS bonds dropped, while shares lost 31% of their value in 1 day.

The Swiss National Bank (SNB) attempted to calm markets by announcing an emergency line of credit worth CHF 50bn. But there was no stopping one of the most aggressive and fastest deposit runs at this point — as withdrawals exceeded anything that could be reasonably expected and modeled. Hedging against default also became virtually impossible as credit default spreads rose to extreme levels. In order to avoid panic spreading across the global financial system, Swiss authorities and regulators urged acquisition negotiations that had to be completed before March 20th. On the morning of March 19th, UBS made an offer of CHF 0.25 per share, valuing Credit Suisse at around $1bn, which other investors found outrageous, and then later that day it offered double the price. SNB forced the deal with a final valuation of CHF 3bn including direct financial support by the authorities, as they threatened to remove the CS board if it did not go through.

In May, another regional US bank — First Republic Bank (FRCB) — which had already been suffering since the March stress, was also not able to survive the loss of depositor and investor confidence and was acquired by JP Morgan. It had received a deposit lifeline and a financing facility coordinated by Jamie Dimon with 11 other big banks, but even that could not stem the outflows and rescue the bank.

What should investors learn from this mess?

The collapse of the regional US banks and Credit Suisse in 2023 may not have had the same magnitude and consequences as the Lehman crash a decade and a half before that, but some of the causes can be traced back to that period. The ultra-loose monetary policy that followed the GFC, with the addition of the spectacular fiscal and monetary stimulus of the pandemic era, was certainly among the main culprits. Once inflation hit in 2021–2022 and these policies were rapidly reversed, there was clearly going to be an impact, compounded by the speed with which new technology allows customers and investors to move money. As the tide turned, the real risks that were lurking underneath flashy and trendy business models which thrived in a low-interest rate environment with abundant financing, finally became exposed — showing us who has been ‘swimming naked’.