Collapsed bank turmoil subsides. But is the next storm brewing?

Then inflation struck, like a sudden burst of heat in the economy. Prices of almost everything rose, turning profits for some sectors – including energy production – into burdens, and raising in turn the prospect of wider collapse, due to the erosion of profit margins in much of the rest of the economy.

This is not only the result of the Russian invasion of Ukraine but also the Covid-19 pandemic that lasted for about two years, which prompted an international response represented in massive amounts of funding, amid an economic slowdown that brought the price of Brent crude oil to about $20.

Experts fear a "Minsky Moment" for the world economy

Some experts think that the current relative calm in the market follows a longer period of reckless speculation, that drove unsustainable growth, and that it may not last.

An analyst at JP Morgan described current conditions as a "Minsky Moment", a term named after the economist Hyman Minsky and used to describe the stage preceding a market collapse in economies where debt levels are too high.

But the global financial sector did not survive the 2008 crisis without lessons and insights. It seems that the most important lesson was not how to avoid a collapse, but how to manage it to minimise its impact.

The reactions we saw following the collapse of SVB -- and then Credit Suisse -- clearly demonstrated the authorities in the countries at the centre of the crisis are no longer willing to absorb losses with public funds. But they can still respond promptly to put an end to the immediate danger.

Regulators and governments need to take comprehensive measures to nip the problem in the bud – quickly, efficiently and positively – by compensating depositors rather than shareholders or bank management. That happened with SVB.

Speed was of the essence with the rescue deal for Credit Suisse. Even for a bank of that size, it was set up within the blink of an eye. The way in which large US banks intervened over First Republic happened also happened immediately.

These were in no way inconsequential measures, whatever the criticisms they may have faced for their validity, or the lack of time for full assessment of their implications.

Credit crunch for Credit Suisse

Credit Suisse will now serve a constant reminder of the fragility of trust in the banking sector. It shows that a good reputation is at the heart of any bank's prosperity, even ahead of its assets and profitability.

This remains the case even after the reforms that followed the 2008 financial crisis, which left more than 400 banks in a total state of collapse over four years. The failure of the Credit Suisse is a big-name reminder that other banks could still face same fate.

There have been efforts by banks since 2008 to strengthen their capital and ensure sound management. However, this did not prevent US banks from incurring unrealised losses of $620 billion due to assets whose value depreciated and have not yet been sold, according to the Federal Deposit Insurance Corporation (FDIC).

Such losses are expected to increase if the Federal Reserve raises interest rates further. The global stock market value of banks has decreased by about $459 billion since the beginning of March.

Even before the spate of US banking failures, which were in part exposed to the collapse in crypto-currency markets, wider commercial banking profits were already under pressure from deteriorating asset values, a slowdown in growth for loans and the rise in interest rates paid on deposits.

Fertile ground for panic

The domino effect of a failed bank means that one institution can bring down others with it. And the individuals and businesses who trust banks with their money are at risk. Any run of depositors seeking withdrawals can make matters worse.

Analysts at Moody's frame the problem like this: "The sharp increase in emergency borrowing by banks from the Federal Reserve reflects funding and liquidity pressures at these banks, driven by the decrease in depositor confidence." They concluded that current data is "consistent with Moody's negative outlook on the US banking system."

It leaves us with an unprecedented level of uncertainty, even compared to when the pandemic was at its peak, according to Stephen Miran, a former senior advisor at the US Treasury. And it comes in a world where information circulates at lightning speed, which was not the case during the 2008 crisis.

Now, depositors and investors alike are faced with a massive amount of conflicting information and indicators, with less time to distinguish between what is right and what is wrong. As a result, it becomes easier to follow the herd in conditions when the herd is more likely to be wrong. 

This creates fertile ground for panic. Such conditions are idea for trust in the banking sector to collapse. They explain why the run-on deposits at SVB was so frantic – reaching $42 billion in a single day – and the repercussions.

Despite it all, central banks have no choice but to continue their fight against inflation. That means they will have to exert more pressure on the already-struggling system via higher interest rates.

Contrary to the hopes of Jerome Powell, the chairman of the US Federal Reserve, many economists believe that a "safe landing" is no longer possible in the foreseeable future and that a recession is inevitable.

Economist and president of Queens' College, Cambridge, Mohamed El-Erian, agrees, stressing that the Federal Reserve will not be able to reach its 2% inflation target without crushing the economy and that there is a need is for a higher target, which may realistically get to 3% or 4% if more stability were to be established.

This all comes as the international political scene is hardly looking calm or supportive of the global economy. There is the war in Ukraine and the increasingly hostile feel to relations between China and the US.

Meanwhile, the deadline on raising the debt ceiling on Washington's borrowing looms, a potential source of disruption even in times of calm on international markets. This time around, it arrives amid the growing talk around the decline of the dollar's role internationally.

Even reassuring analysis concedes at it margins that there is much uncertainty ahead. After the shockwaves in the banking sector have subsided, the markets may be calm for now. But in the financial and trading capitals of a troubled world, there is a sense that this is the kind of calm that comes before a storm.