Deposit flight shows damage from the latest banking crisis is far from done

The effects of a long period of low interest rates being followed by sharp rate increases are likely to be long-lasting and produce more than a mild recession
Rather than repeatedly tightening regulations after a crisis, policymakers should focus on ending quick fixes such as monetary or fiscal easing

Anthony Rowley

Published: 1:00am, 23 Apr 2023

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For those people who are naive or foolish enough to believe the latest banking crisis is over – and there appear to be many of them still, including commentators who should know better – the continuing flight of bank deposits must have come as a shock, although it should not have.

Even a cursory analysis would suggest that, after a long period of record low interest rates during which borrowing at household, corporate and government levels reached new heights, successive and sharp rate increases are likely to have a deep-seated and long-lasting impact.

The reality is that even if the biggest banks are well capitalised and regulated enough to avoid collapse, many smaller banks are suffering from large outflows of deposits. The widespread credit tightening this is provoking is likely to trigger more than a mild economic recession.

Asia is not immune to this coming crisis. Even if the shockwaves emanating from the likes of Silicon Valley Bank in the United States or Credit Suisse in Switzerland are weakening, the fact that Asian economies are more bank-dependent and less capital market-reliant than those elsewhere will tell.

Asia’s corporate sector, and especially that of “emerging” Asia, is highly exposed in terms of borrowing relative to gross domestic product size, according to the Institute of International Finance data at the end of 2022. The ratio for corporate Asia was 130 per cent, well above the 97 per cent figure in mature economies.

Even if many financial analysts and investors have somehow managed to miss the significance of what this combination of high indebtedness with rising interest rates implies for a highly stressed banking sector, depositors have not.

As the Financial Times reported recently, the deposit flight from US banks has been “turbocharged by the collapse of Silicon Valley Bank and two other US lenders”. Customers have pulled around US$800 billion in deposits from US commercial banks in the past year since interest rates began their rise.

Runs on bank deposits can be partly compensated for by central banks stepping in and providing the affected institutions with sufficient financial liquidity to keep going, or by seeking to staunch deposit outflows with assurances of banks’ soundness.

These are only temporary measures, however. They do not address the now urgent issue of banks, which see their deposits quickly evaporating, naturally becoming nervous about expanding their existing loan books, or even continuing to lend at all, in the wake of such trauma.

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As former US Treasury secretary Henry Paulson said in an interview with the Financial Times, “if you’re running a small or regional bank right now, you wouldn’t be lending”. That leads to a credit squeeze and, as Paulson added, “it’s pretty likely we’ll see a recession” as a result.

Paulson was at the centre of the action during the 2008 global financial crisis, so he knows a thing or two about crises. His expressions of concern about how quickly financial crises can spread with the aid of social media should be taken seriously.

This is a subject that is also beginning to exercise the minds of other responsible people. Hung Tran, a former executive managing director at the Institute of International Finance and now a non-resident senior fellow at the Atlantic Council, is one such voice of caution.

As he has pointed out, the spate of bank failures in March could herald the first banking crisis in a digital world where online banking and rumours spread on social media in real time have brought down banks in matters of days, not weeks as in the past.

A law enforcement official stands in an entryway as customers queue outside a Silicon Valley Bank branch location in Wellesley, Massachusetts, on March 13. Photo: AP

Tran notes that the speed and scale of bank runs have overturned guardrails and left regulators little time to respond. He suggests that, apart from changing the law exempting US banks with assets less than US$250 billion from the full force of the Dodd-Frank Act and strengthening bank supervision, reform should focus on liquidity coverage ratios and on deposit insurance.

Those who took comfort in the idea that the collapse of Silicon Valley Bank and Signature Bank were of local significance only and not internationally active were quickly disabused of that notion by the collapse of Credit Suisse thousands of kilometres away in Europe.

As noted at a March meeting of the Basel Committee on Banking Supervision, the “internationally active” concept is outdated. Rather, policymakers need to explore whether rules should be applied to banks of “international relevance” or those with the potential to destabilise the wider financial system.

At the end of the day, prevention is always better than a cure. Rather than repeatedly having to tighten regulations after the event of a banking crisis, it would help if policymakers were to focus on putting an end to quick-fix policymaking such as monetary or fiscal easing and subsequent tightening.

Highly relevant in this context is the call by Augustin Carstens, the head of the Bank for International Settlements, for governments and central banks to stop seeking quick fixes to boost their economies each time recession hits or growth stalls and to tackle deeper economic reforms instead. A loud “amen” to that.

Anthony Rowley is a veteran journalist specialising in Asian economic and financial affairs