The 2023 banking crisis: What Happened and what’s Next?

The year 2023 already saw a major banking crisis that impacted economies around the world. The crisis was caused by a combination of factors, including overleveraging, inadequate risk management, and global economic instability. In this article, we will take a closer look at what happened during the crisis, its effects on the banking sector, and what we can expect in the future.

During March, several banks, such as Silvergate Bank, Signature bank among others have collapsed, with SVB paving the way.

Silicon Valley Bank, the 16th-largest bank in the U.S., failed after depositors hurried to withdraw money this week amid anxiety over the bank's health. The bank served mostly technology workers and venture capital-backed companies, including some of the industry's best-known brands.

It was the second biggest bank failure in U.S. history after the collapse of Washington Mutual in 2008.

Garry Tan, CEO of Y Combinator, a startup incubator that launched Airbnb, DoorDash and Dropbox and has referred hundreds of entrepreneurs to the bank, was quoted saying:

"This is an extinction-level event for startups… I have been hearing from hundreds of our founders asking for help on how they can get through this.”

What caused the banking crisis?

If we take SVB as an example, many tech companies used SVB to store the cash they used for payroll and other business costs.

Like all banks, the bank invested a sizable part of the deposits, including significant investments in long-term US government bonds, including those secured by mortgages.

And while bonds are usually as secure as investments can be, they are inversely related to interest rates; as rates increase, bond prices decline. As a result, SVB's bond holdings started to lose a lot of value when the Federal Reserve began raising rates quickly to fight inflation.

That too, wasn’t enough to trigger a collapse: If SVB were able to hold the bonds for a number of years until they mature, then it would receive its capital back. However, as economic conditions changed for the worst over the last year, tech companies started drawing on their deposits.

SVB didn’t have enough cash on hand, and so it started selling some of its bonds at steep losses, spooking investors and customers.

It took just 48 hours between the time it disclosed that it had sold the assets and its collapse.

Is the banking crisis all SVB’s fault?

No. The banking crisis of 2023 was caused by a combination of factors. One of the main causes was overleveraging, which is when banks take on too much debt. In the years leading up to the crisis, many banks around the world had taken on significant amounts of debt, which made them vulnerable to economic shocks.

Leveraging allows banks to hold a fraction of the asset they can invest or lend, but the last time it went out of hand to generate profits, the Great Recession occurred. For example, currently, JPMorgan Chase bank has 269 billion in assets, and over 3.2 trillion in leveraged assets.

Another factor was inadequate risk management. Some banks had taken on risky loans and investments without fully understanding the potential risks. When these risks materialized, it led to significant losses for the banks.

Finally, global economic instability played a role in the crisis. In 2023, the global economy was already showing signs of slowing down, and the pandemic had further exacerbated the situation. As a result, many banks were struggling to stay afloat. Global growth is slowing sharply, with worldwide economic output projected to be just 1.7% in 2023, according to the latest analysis from the World Bank Group.

What were the effects of the banking crisis?

The banking crisis of 2023 had significant effects on the banking sector and the wider economy. One of the main effects was the collapse of several major banks. These collapses led to significant job losses and economic turmoil.

As a domino Shares of Credit Suisse bank dropped 20% in mid-March. A week later, shares in Deutsche Bank have fallen 14% in a single day, dragging down other major European banks and reigniting fears about a widening banking sector crisis.

Deutsche Bank is one of 30 banks considered globally significant financial institutions, so international rules require it to hold higher levels of capital reserves because its failure could cause widespread losses.

"Markets are wild. We move from the problems of American banks to those of European banks, first of all Credit Suisse," said Carlo Franchini, head of institutional clients at Banca Ifigest in Milan.

The crisis also had an impact on the availability of credit. As banks struggled to recover from the crisis, they became more cautious about lending, which made it more difficult for individuals and businesses to obtain credit.

Furthermore, the crisis led to a loss of confidence in the banking sector. Many people began to question the safety of their deposits, which led to a run on several banks.

What comes next?

The banking crisis of 2023 has left many wondering what comes next. In the short term, we can expect to see continued consolidation in the banking sector. Many banks will merge or be acquired in an effort to reduce costs and improve efficiency—just not right away.

Already, we’ve seen government-led acquisitions of Credit Suisse by UBS (UBS) as well as much of what was Signature Bank by New York Community Bancorp (NYCB) subsidiary Flagstar. Not to mention the continuing effort by the Federal Deposit Insurance Corp. to sell fallen SVB Financial.

In addition, we can expect to see increased regulation of the banking sector. Governments around the world will be looking for ways to prevent another crisis from occurring, and this will likely involve stricter regulations for banks.

Finally, we can hope to see a shift in the way that banks operate. Banks will need to focus on improving risk management and avoiding overleveraging. They will also need to focus on providing better customer service and developing new products and services to stay competitive.

What about the banking crisis in India?

India was not immune to the global banking crisis.

If the US Federal bank will increase the scale and speed of interest rate hikes, it will have implications for global capital flows in the medium term and is bound to impact emerging economies like India.

The era of easily borrowed money is over and world economies will have to adjust to it. There will be no more scope for borrowing at nearly zero interest from Western or Japanese markets to invest in emerging economies like India for higher returns.

Amid the recent turmoil in the sector globally, India's governor of the Reserve Bank of India said that the “banking system continues to be stable and resilient, and lenders have built sufficient buffers to shield themselves from any unforeseen stress. We continuously do stress tests. We identify any potential build-up of risk in any institution, and we constantly engage with the management of banks through supervisors," RBI Governor Shaktikanta Das said.

How has the banking crisis impacted forex?

One of the main effects has been increased volatility in currency exchange rates. When the crisis first hit, many investors and traders rushed to liquidate their positions in certain currencies, which led to significant swings in exchange rates.

In addition, the crisis has also led to a shift in the way that investors view different currencies. Safe-haven currencies such as the US dollar, Swiss franc, and Japanese yen have become more attractive to investors, while currencies associated with more risky economies have seen a decline in demand.

The banking crisis has also had an impact on cross-border trade and investment. As banks have become more cautious about lending, it has become more difficult for businesses to obtain financing for international trade and investment. This has led to a decline in cross-border transactions, which has further contributed to the volatility in forex markets.

Furthermore, the crisis has highlighted the importance of risk management in forex trading. Traders and investors need to be aware of the potential risks associated with trading in certain currencies and should be prepared to adjust their positions accordingly.

Conclusion

The banking crisis of 2023 was a major event that had significant effects on the banking sector and the wider economy. While the crisis has caused significant damage, it has also highlighted the need for greater regulation and improved risk management in the banking sector.

As we move forward, we can expect to see continued efforts to improve the stability and efficiency of the banking sector, both in India and around the world. These efforts will likely involve increased collaboration between governments, regulatory bodies, and banks themselves.

It is also important to note that the banking crisis of 2023 may have some long-term effects on the way that people view and use banks. The loss of confidence in the banking sector could lead to a shift towards alternative forms of finance, such as cryptocurrencies, fintech startups and peer-to-peer lending platforms.

In addition, the crisis could also lead to a greater emphasis on financial literacy and education. Many people were caught off guard by the crisis and did not fully understand the risks associated with their banking activities. By improving financial literacy, we can help to ensure that people are better prepared for future economic shocks.