Bank panic raises spectre of 2008 financial crisis, may bring lasting change

WASHINGTON – The lightning speed at which the banking industry descended into turmoil has shaken global markets and governments, reviving eerie memories of the financial crisis. Like 2008, the effects may be long-lasting.

In the space of a week, two US banks have collapsed, Credit Suisse Group needed a lifeline from the Swiss and America’s biggest banks agreed to deposit US$30 billion (S$40 billion) in another ailing firm, First Republic Bank, in a bid to boost confidence.

Evoking recollections of the frenzied weekend deals to rescue banks during the 2008 financial crisis, the turmoil prompted monumental action from the United States Federal Reserve, US Treasury and the private sector. Similar to 2008, the initial panic does not seem to have been quelled.

“It does not make any sense after the actions of the Federal Deposit Insurance Corporation (FDIC), the Fed and the Treasury (last) Sunday that people are still worried about their banks,” said Mr Randal Quarles, a former top banking regulator at the Fed. He now faces renewed criticism over his agenda at the Fed, where he oversaw efforts to reduce regulations on regional banks.

“In an earlier world, (the actions) would have calmed things by now,” he said.

The collapse of Silicon Valley Bank (SVB), which held a high number of uninsured deposits beyond the US$250,000 FDIC guaranteed limit, shook confidence and prompted customers to withdraw their money. US bank customers have flooded banking giants, including JPMorgan Chase, Bank of America and Citigroup, with deposits. This has led to a crisis of confidence and a steep sell-off in smaller banks.

“We do a lot of contingency planning,” said Mr Stephen Steinour, chief executive of Huntington Bancshares, a lender based in Columbus, Ohio. “We started to do the ‘what-if scenario’ and looked at our playbooks.”

As banks grapple with short-term shocks, they are also assessing the long term.

The swift and dramatic events have fundamentally changed the landscape for banks. Now, big banks may get bigger, smaller banks may strain to keep up and more regional lenders may shut. Meanwhile, US regulators will look to increase scrutiny on mid-sized firms bearing the brunt of the stress.

US regional banks are expected to pay higher rates to depositors to keep them from switching to larger lenders, leaving them with higher funding costs.

“People are actually moving their money around; all these banks are going to look fundamentally different in three months to six months,” said Mr Keith Noreika, vice-president of Patomak Global Partners and a former US comptroller of the currency.

2008 all over again?

The current crisis may feel frighteningly familiar for those who experienced 2008, when regulators and bankers huddled in closed rooms for days to craft solutions.

Last Thursday’s bank-led US$30 billion boost to First Republic also reminded people of the 1998 industry-led attempt to rescue Long-Term Capital Management, where regulators brokered a deal for industry giants to pump billions into the ailing hedge fund.

With this latest panic, there are differences.

“For anyone who lived through the global financial crisis, the past week is feeling hauntingly familiar,” Mr Josh Lipsky, senior director of the Atlantic Council’s GeoEconomics Centre and a former adviser at the International Monetary Fund, wrote in a blog post. “If you look past the surface, it is clear that 2023 bears little similarity to 2008.”

In 2008, regulators had to contend with billions of dollars in toxic mortgages and complex derivatives sitting on bank books. This time, the problem is less complex as the holdings are US Treasuries, said Mr Lipsky.

And this time, the industry is fundamentally healthy.

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While Congress and regulators whittled away at safeguards for regional banks over the years, there are tougher standards for the biggest global banks, thanks to a sweeping set of new restrictions from Washington in the 2010 Dodd-Frank financial reform law.

This stability was on display on Thursday, when the biggest firms agreed to place billions in deposits at First Republic, effectively betting that the firm would remain afloat. Even so, the firm remains under pressure, with its stock price falling 33 per cent the day after the capital infusion.

“Banks are actually healthier than they were (pre-2008 crisis) because they have not really been allowed to do virtually anything in terms of actually taking true underlying credit risks in their assets,” said Mr Dan Zwirn, CEO of Arena Investors in New York.

Now, bankers and regulators are grappling with an unexpected set of challenges. Deposits, long seen as a reliable source of bank cash, have now come into question.

Those who watched SVB’s quick collapse wonder what role social media, now omnipresent but niche back in 2008, might have played in people pulling out money.

“US$42 billion in a day?” said one senior industry official who declined to be named, referring to the massive deposit flight that SVB saw before its failure. “That is just insane.”

Regulatory lens

The last crisis changed the banking industry as massive firms went under or were bought by others, and Dodd-Frank was enacted. Similar efforts are now under way.

“Now, the regulators know that these banks offer a greater risk to our overall economy than they thought they did. And I am sure they will go back and increase regulation to the extent they can,” said Ms Amy Lynch, founder and president of FrontLine Compliance.

A divided Congress is not likely to advance any comprehensive reforms, according to analysts. But bank regulators, led by the Fed, are signalling they are likely to tighten up existing rules on smaller firms at the centre of the current crisis.

Currently, regional banks with below US$250 billion in assets have simpler capital, liquidity and stress-testing requirements. Those rules could increase in intensity after the Fed concludes its review.

“They definitely must; it is not even should. They must reconsider and change their strategies and the rules that were adopted,” said Dr Saule Omarova, a law professor whom President Joe Biden once nominated to lead the Office of the Comptroller of the Currency.

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The recent crisis has also put big banks back on Washington’s radar, possibly erasing years of work by the industry to escape the tarred reputation it carried from the 2008 crisis.

Prominent big-bank critics like US Senator Elizabeth Warren are criticising the industry for pushing simpler rules, in particular a 2018 law allowing mid-sized banks like SVB to avoid the most vigorous oversight.

Other policymakers are reserving ire for regulators, wondering aloud how SVB could have ended up in such a dire position while watchdogs were on the job.

The Fed plans to conduct an internal review of its supervision of the bank. But there are growing calls for an independent look. Last Thursday, a bipartisan group of 12 senators sent a letter to the Fed, saying it was “gravely concerning” that supervisors did not identify weaknesses ahead of time.

“SVB is not a very complicated bank,” said Dr Dan Awrey, a Cornell University law professor and bank regulation expert. “If big and not-complex cannot get the appropriate supervision, that then raises the question: Who on earth can we regulate?”