By Romel Dhalla
Systemically Important Banks – we call them SIBs – were created in the aftermath of the 2008 financial crisis. They were deemed "too big to fail" and were given special protections offered by central banks and bureaucratic agencies. The consequences of a massive bank failure were made all too real when Lehman Brothers, Washington Mutual, and other financial institutions could no longer remit cash owed to their depositors or became insolvent.
At that time, it was apparent that banks had gone too far by leveraging their deposits into seemingly safe investments that dropped precipitously in value – mortgages people couldn’t pay and that they shouldn’t have been qualified for in the first place, bundled into "mortgage-backed securities". How history repeats itself. This time, rapid increases to overnight lending rates set by central banks were thought to be the cure to the inflation bogeyman, and this seemed to be working as inflation growth began to slow – and the world celebrated with a rebound in the financial markets in January.
This was evidently premature, as the unintended consequence of these rapid interest rate increases caused bond prices to drop massively. The longer term the bond, the bigger the price drop. This is well known and considered basic financial knowledge for those in my industry, so one has to wonder what banks were doing when they moved large sums of cash deposits into long bonds, as Silicon Valley Bank (SVB) did. Major financial malpractice. They should have known better, but they were chasing the slightly higher yields offered by longer bonds. At SVB, the problem of incompetence was compounded by greed. Worse yet, one of the better policy-based US administrations of the modern era, President Trump’s, erred when it waived regulatory oversight of mid-sized banks, claiming it was too burdensome and costly.
So, a combination of factors – incompetence, greed, and deregulation, now presents us with a situation where the world’s economy hangs by the frayed threads of faith people have in their financial institutions. Despite the expeditious and broad proclamations from governments that depositors are to be made whole, people have figured that they should move deposits larger than those insured by deposit insurance agencies over to SIBs – thus, bigger banks grow even bigger. The regional banks that lend to businesses that the big banks can’t or don’t want to serve are hollowing out. Also, many may quickly be forced to lay off staff as deposits – which they in turn lend or invest to make a profit – disappear. Worse, these banks may have to close as losses mount. The big SIBs have responded by moving capital from their balance sheets to the smaller ones, but it is unknown if this stopgap measure will stem the bleeding. The federal reserve and other agencies are promising to support depositors, but they need to do more to assist banks with their balance sheets, which ultimately requires, to put it simply, printing more money. This, unfortunately, gets us back to our original problem of fueling inflation. We are caught in a vicious cycle.
So, where does it end? It’s very hard to see a way out, especially when you add the laundry list of global geopolitical and economic problems that remain unsolved. The future looks dark. It looks like a prolonged and deep recession.
Canada has two global SIBs, RBC and TD. The four other major banks, BMO, BNS, CIBC, and NBC, are designated as domestically significant. We have no choice but to hope that the protective measures in place to keep these banks solvent actually work without causing more inflation.
I absolutely hate saying it, but this is why, I think, cryptocurrencies are rising in value. Once considered a joke by many, especially recently as they plummeted in value, these vehicles now seem to provide some kind of solution for people who are looking for an escape from the financial system most of us have relied upon all our lives. Their supporters can now call out their detractors, posing the same question, "What is the fundamental value of dollars if banks fail?" Touché.
For my part, sticking with the SIBs seems like the best way to go. If these banks fail, well, everything does. So, we must hope for human ingenuity and dogged perseverance to pull us through this dark time. Given the statements by most agencies and world leaders, who are still chasing perpetually failing global warming targets, fraudulent ESG (Environmental, Social and Governance), and divisive DEI (Diversity, Equity and Inclusion) policies rather than focusing on the real problems of the day, I fear we have yet more pain, perhaps much more, to see through before things get better.
As I've said in other columns before, the solution often comes from a place we don't suspect. So, let's all hope a white knight comes riding in to rescue the banks… and us.
Romel was a Portfolio Manager and Investment Advisor for two major banks for 17 years and now focuses on strategic corporate finance for businesses.
