May the financial fracasos be with us

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April ended on a predictable note for this uncertain year: with the fourth notable US bank collapse in 2023, after a five-day run on three institutions in March (Silvergate, Signature, and Silicon Valley Bank), and the largest since 2008. On the aptly named May Day, JPMorgan Chase acquired the assets of First Republic Bank, which had released a report in late April acknowledging that other bank runs had triggered clients to withdraw over $100 billion from it as well. As First Republic had already been borrowing heavily from the Federal Reserve, the “lender of last resort” that tends to make investors nervous, the bank’s shares had lost 97 percent of their value over four months.

The uncertainty hasn’t ended, either, with indices like the S&P 500 charting concerning drops in regional bank shares in the past few days, including precipitous shifts in entities like Utah’s Zions Bancorporation and Los Angeles’ PacWest Bancorp. For everyday citizens, the impact is clear: banks worried about losing what reserves they have left lend less, and look for ways to up their future assets, even at cost to inflation-strapped clients. The hit to small businesses seeking start-up and maintenance cash is real, and with tighter lending, we see stronger signs of that “mild recession” US officials acknowledged in April, too.

HSBC, which rescued Silicon Valley UK at a cost of one British pound and tripled its first-quarter profits in the process, was quick to assure watchers, in the wake of First Republic’s takeover, that no greater crisis is coming; this latest crash was simply a matter of poor risk management among a few institutions, in a season of bank runs now coming to a close.

If so, it’s a season of destabilization that impacted more than the US, and has ripple effects worth deeper consideration. In Europe, where banking institutions generally have more capital to serve as a buffer, the consequences of its own March crash, of the 167-year-old Credit Suisse Bank, are still being processed through promises of banking reform.

At the time, Switzerland’s central bank brokered a deal to save the institution. At April’s end, it promised a fuller review of regulations policy: a sound move, to calm skittish European clients. Reports are now emerging that show significant savings withdrawals from major European banks this year, as clients diverted their holdings mostly to money market funds. The aim for clients was to find investments that could at least counteract inflation, which has been in double-digits for many European countries. Europe announced earlier this year that it would avoid recession, but in the cute language of economics, much has been made of the “headwinds” it still faces while trying to manage inflation and stabilize recovery efforts.

Western banking crises are also playing out in a war-framed world that is narrowly avoiding global recession, against the ongoing complexity of Russia’s deepening ties with China, and amid the rise of India as the world’s largest country by population, with robust growth metrics to match. Since economics is at its heart a confidence game, it’s deeply important to Western banking structures that at least the appearance of stability be maintained.

However, there are two facets to this problem that merit our attention, this month and going forward. No, not so much as backseat economists, but as human beings attentive to any risks and possibilities for humanist public policy. The financial system is “wilding” in tricky ways (not unlike the murky backroom world of financing ahead of the 2008 recession), and our current regulatory apparatuses might not able to keep pace. What then?

The growing quaintness of bank monopolies

The first facet was highlighted by JPMorgan Chase’s takeover of First Republic on Monday, and by HSBC’s confident remarks on Tuesday: namely, the growing possibility of a wave of bank mergers to consolidate other precarious ventures in the US. As The Economist recently noted, the US has around 4,700 banks, or one for every 71,000 residents: a number that has been steadily shrinking since 1984, when there were nearly four times as many banking institutions, to allow for greater market stability.

Rules classifying banks in different categories of risk and responsibility might undergo changes in the coming months that would make it easier for more mergers to transpire. Regulators are cautiously optimistic that consolidation will reduce the dangers revealed by the Silicon Valley Bank crash in particular: a bank that was supposed to be small enough not to cause the market crisis it did, when it went under for want of greater oversight.

Higher regulation tends to come with higher costs, which is why regulators have generally used a lighter touch for small- and midsized banks. However, now that even midsized banks can cause outsized problems, it follows that the state would make it easier for smaller banks to move into higher asset brackets through mergers. They would then be held to higher regulatory standards against future loss (a move that would help them and of course all their clients), while spreading regulatory costs across the whole merged enterprise.

Win win, right?

One traditional downside to mergers is, of course, the threat to competition, which everyday consumers recognize as the danger of monopoly. Fewer options on the market can mean a greater risk of clients being stuck with inescapably high service pricing, for example.

Ostensibly, this risk is considered in analysis ahead of any potential consolidation, but those analyses don’t always encompass the full landscape of competition in our current financial markets. This is because something unusual is taking place alongside the central crisis for traditional banking: the rise of off-the-book competitors in the form of “shadow banking”.

And that’s definitely changing the territory for regulators pursuing global financial stability.

The financial system is “wilding” in tricky ways, and our current regulatory apparatuses might not able to keep pace. What then?

Nonbank financial intermediaries (NBFIs), fintech, and Big Tech

Last month, the International Monetary Fund (IMF) offered a warning about shadow banking: an industry of far less regulated financial institutions, including pension funds, hedge funds, private equity funds, insurance bodies, structured investment vehicles, and limited-purpose finance companies, that now holds fifty percent of the world’s assets.

The Federal Reserve, along with other nations’ central banking authorities, has long called for more oversight in this sprawling and growing domain of financial products, which along with fintech and related Big Tech holdings (crypto), present a huge market risk. This is because they rarely have their own loss-absorbing capital, but can easily over-leverage themselves and trip into what’s more endearingly called a “liquidity mismatch” (in simpler terms, promising clients a deal that, if too many clients take up at the same time, the institution lacks the funds to make good on). When these muck-ups happen, it still falls on traditional banking to cover the costs of shadow banking’s risks.

The problem becomes obvious, no?

READ: Bankman-Fried Arrested: Now what’s to be done about ponzinomics?

Which is why the IMF recently noted the danger of increasing regulation in mainstream banking to such a point that everyday investors, like the European clients recently reported to have moved significant holdings from traditional banks this year, will simply look for better deals elsewhere. So long as those “better deals” are through institutions that ultimately dump risk back on the traditional system, which in turn gets bailed out at routine cost to average citizens rarely granted the same kind of social welfare as corporations, the whole system remains vulnerable to collapse.

Fun times.

So although there are tentative signs that global and local recessions are still manageable, even as inflation remains an issue, the uncertainty that continues to be reported in North American and European banking systems merits our attention: because the choices made by state regulators, in response to these spectacular recent institutional failings, need to be made with a mind to much deeper systemic problems.

A long unchecked rise of secondary financial markets has led to disaster before, but in an era of equally unchecked Big Tech products, we’re facing a confidence crisis around traditional financial authority that could either yield catastrophic results—or invite a long overdue conversation about alternatives that might better serve us all.

Which future will we lean into next?