{"id":1067,"date":"2023-04-04T00:00:00","date_gmt":"2023-04-04T00:00:00","guid":{"rendered":"https:\/\/www.rbcwealthmanagement.com\/en-eu\/2023\/04\/04\/a-crisis-for-a-few-banks-is-not-a-banking-crisis\/"},"modified":"2024-02-05T09:20:35","modified_gmt":"2024-02-05T14:20:35","slug":"a-crisis-for-a-few-banks-is-not-a-banking-crisis","status":"publish","type":"post","link":"https:\/\/www.rbcwealthmanagement.com\/en-eu\/insights\/a-crisis-for-a-few-banks-is-not-a-banking-crisis","title":{"rendered":"A crisis for a few banks is not a banking crisis"},"content":{"rendered":"\n<p><strong>By Atul Bhatia, CFA<\/strong><\/p>\n\n\n\n<div class=\"wp-block-rbcwm-well well is-style-is-style-b-blue-tint-4 b-blue-tint-4 mb-3 migrated\">\n<ul class=\"wp-block-list\">\n<li>With bank failures back in the headlines, investors are understandably concerned about the prospects of a return to the turmoil of 2008 and the global financial crisis.<\/li>\n\n\n\n<li>We believe that recent events are fundamentally distinct from the problems of 15 years ago and that policymakers\u2019 existing toolkit is sufficient to bring stability to the sector.<\/li>\n\n\n\n<li>Our concerns are focused on potential unintended consequences from regulators\u2019 attempts to assign losses and avoid moral hazard.<\/li>\n<\/ul>\n<\/div>\n\n\n\n<p>       Financial turmoil inevitably awakens memories of 2008-09 and the global       financial crisis. We believe strongly that the recent events in the U.S.       financial system are not the early stages of a 2008 repeat; 15 years ago,       we had a banking crisis and today we have a crisis at a few banks. This       distinction is critical for investors, in our view.     <\/p>\n\n\n\n<p>       We see the relative paucity of new measures by U.S. policymakers to date       as a reflection of the ultimate manageability of today\u2019s issues. But we       also believe it could mark a potentially unwise attempt to assign losses       between depositors and investors, a move that we see as fraught with       potential unintended consequences.     <\/p>\n\n\n\n<h2 class=\"wp-block-heading\" id=\"h-banking-basics\">Banking basics<\/h2>\n\n\n\n<p>       Banking at its core is a relatively simple business. Depositors give an       institution savings, and banks invest those savings. Sometimes banks buy       existing investments such as U.S. Treasury bonds, and sometimes banks       create their own investments by making loans. As long as the bank\u2019s       investments return more in interest and principal than it owes depositors,       the bank is in good shape. Since some borrowers don\u2019t pay and some bonds       go bad, banks also have money from their owners, referred to as either       capital or equity, to cover those losses.     <\/p>\n\n\n\n<p>       One complication for banks is that depositors can, by and large, withdraw       their money at any time, but banks don\u2019t always have the same luxury.       Borrowers can\u2019t be forced to repay a mortgage on demand and bond prices       may have temporarily declined. To allow for this, banks always try to keep       plenty of cash on hand to meet depositor withdrawals, but they cannot keep       it all in cash or they would not have a way of generating the cash flow to       pay interest or dividends to investors.     <\/p>\n\n\n\n<h2 class=\"wp-block-heading\" id=\"h-past-problems\">Past problems<\/h2>\n\n\n\n<p>       In 2008, banks had a genuine problem. Assets they had carried on their       books were worth less (and in some cases worthless) because of extremely       lax loan standards that resulted in widespread loan defaults. That created       a hole in the banks\u2019 capital and some banks were likely technically       insolvent; if we added up all the money they would ever receive from their       investments, the amount would have been insufficient to pay all the money       that the bank owed.     <\/p>\n\n\n\n<p>       Fixing this type of permanent drop in future income requires capital.       Capital is risky, and as a result it\u2019s expensive, even in good times. In       2008-09, banks needed someone to replenish money that had already been       lost, and that is a particularly difficult request. Ultimately, the       government had to step in and provide assistance.     <\/p>\n\n\n\n<h2 class=\"wp-block-heading\" id=\"h-the-easy-part\">The easy part<\/h2>\n\n\n\n<p>       Today\u2019s issue is not that the expected money from banks\u2019 assets will never       be received. Many of the assets with the steepest price declines are U.S.       Treasuries that we, and all market participants that we are aware of,       fully expect to be repaid on time and in full.     <\/p>\n\n\n\n<p>       The issue today is that more depositors than normal are demanding their       cash, driven by fear of bank failure. It\u2019s a classic bank run that the       existence of the deposit insurance is supposed to avoid.     <\/p>\n\n\n\n<p>       There are two ways to deal with a bank run. One is to calm depositors\u2019       fears and discourage them from removing money. To a certain extent, that       has worked. Much of the money being withdrawn isn\u2019t leaving the banking       system overall but moving from a few small banks to larger ones. This is       not ideal for the long-term health of a competitive banking system, but it       is a far cry from 2008\u2019s global financial instability. It is also why we       think this is a crisis for some banks but not for the banking system.     <\/p>\n\n\n\n<p>       The other way to deal with a bank run is to find new money for the bank to       use. To a large part, that\u2019s already happened. The Federal Reserve\u2019s new       lending facility allows banks to use central bank financing to replace       depositor money for certain U.S. Treasury and mortgage bonds. Critically,       the Fed allows the banks to fund the bonds at the face value of the       investment, meaning that in most cases this is a near seamless transition       for depositor funding amounts; it\u2019s more expensive, but it\u2019s there.     <\/p>\n\n\n\n<p>       The existing Fed mechanism doesn\u2019t work for all types of bank investments.       Commercial and individual loans are not homogenous risks like government       bonds. But the central bank has plenty of experience in crafting joint       solutions for these types of assets with the U.S. Treasury Department,       where the Fed provides financing to non-government assets and Treasury       absorbs any realised credit losses. Historically, these arrangements have       worked to the Fed\u2019s and the government\u2019s advantage.     <\/p>\n\n\n\n<p>       Turmoil in European banks could add to the pressure on certain U.S.       financial institutions and potentially raise the stakes for the Fed and       Treasury. But with asset quality sound and with our view that major       European banks are likely to continue to perform on their obligations, we       think this remains a problem well within the capacity of the U.S.       government.     <\/p>\n\n\n\n<h2 class=\"wp-block-heading\" id=\"h-moral-hazard\">Moral hazard<\/h2>\n\n\n\n<p>       Since the current problem should be relatively easy to solve, the obvious       question is why have policymakers failed to act more decisively.     <\/p>\n\n\n\n<p>       We see three reasons. First, existing legal authority to act is murky, at       best. The Federal Deposit Insurance Corporation (FDIC) has wide powers to       resolve banks in receivership, but absent congressional action it is       relatively hamstrung in preventive moves. Second, because the overall       system is not in crisis\u2014as noted, large banks have seen deposit       inflows \u2013 there is less immediate pressure on regulators to push the limits       of their authority. Finally, and we believe somewhat hazardously,       policymakers, in our view, are willing to see bank failures in part to       combat potential moral hazards created by the 2008 bailouts. We think they       are using this episode to reinforce that investors in banks \u2013 buyers of       bonds, preferred shares, and stocks \u2013 are at risk if a bank fails.     <\/p>\n\n\n\n<p>       While this is not necessarily a bad message to send, it is a different       message than investors had perhaps believed after 2008. In 2008, we think       that investors largely \u2013 and reasonably \u2013 concluded that investments made in       sound financial institutions would be respected in a resolution if the       bank later fell as part of an external risk event. A full government       guarantee may not have been thought likely, but given the highly regulated       nature of the institutions and the key role banks play in the economy,       some consideration for investors may have been expected.     <\/p>\n\n\n\n<p>       We are worried that policymakers may get what they seem to wish for: a       sudden repricing of the risks in investing in bank bonds and stocks. If       that were to occur, it could make it difficult for some banks \u2013 particularly       smaller institutions \u2013 to borrow sufficient money in the public markets at       economically viable rates to support their current levels of lending, let       alone the type of loan growth companies have come to rely on. The impacts       would likely be felt across the economy but would be especially       detrimental for small businesses that rely on local lenders.     <\/p>\n\n\n\n<p>       For investors, we think it is key to remember that the primary support for       any investment is the fundamental underlying business and, broadly       speaking, we believe the U.S. banking system\u2019s fundamentals remain solid.       Even if the goalposts have moved from 2008 on the impact to investors in       the case of default, that change does not directly impact investors in       institutions that remain in operation. To state it plainly, we think that       will be the case for the overwhelming majority of U.S. banks.     <\/p>\n\n\n\n<h2 class=\"wp-block-heading\" id=\"h-not-the-end\">Not the end<\/h2>\n\n\n\n<p>       The 2008-09 global financial crisis was a critical, if not <strong>the<\/strong> critical,       financial event of the century to date. It\u2019s understandable that investors       remain scarred by the event and that any word of bank failures brings       fears. But we believe the underlying causes of the current market upheaval       are both less substantial for the banking system and more easily       controlled by existing central bank and regulatory mechanisms.     <\/p>\n","protected":false},"excerpt":{"rendered":"<p>Several factors distinguish the recent turmoil from the 2008-09 crisis. We discuss U.S. policymakers\u2019 current approach, and the risks for investors in U.S. banks.<\/p>\n","protected":false},"author":15,"featured_media":1069,"comment_status":"closed","ping_status":"closed","sticky":false,"template":"","format":"standard","meta":{"_acf_changed":false,"rbcwm_post_date":"2023-04-04 00:00:00.0","editor_notices":[],"rbc_url_alias":"","rbcwm_featured_desktop_image_position":"","rbcwm_featured_mobile_image_position":"","_jetpack_memberships_contains_paid_content":false,"footnotes":""},"categories":[80],"tags":[100,102,103],"rbcwm_content_owner":[506],"rbcwm_need":[],"rbcwm_segment":[],"rbcwm_solution":[],"rbcwm_topic":[81],"rbcwm_channel":[],"rbcwm_format":[],"class_list":["post-1067","post","type-post","status-publish","format-standard","has-post-thumbnail","hentry","category-analysis","tag-equity-market-news","tag-equity-return","tag-return-of-capital","rbcwm_content_owner-pag","rbcwm_topic-global-insights"],"acf":{"rbcwm_subtitle":"Several factors distinguish the recent turmoil from the 2008-09 crisis. 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