On the weekend of March 11—when the U.S. Federal Reserve (Fed), the FDIC, and U.S. Department of the Treasury mulled over what happened and what to do about the failures at Silicon Valley Bank and Silvergate Bank—Credit Suisse (CS) must have felt like the “big gorilla in the room.” At least that was one colorful description put to Fed Chair Jerome Powell at his March 22 post-Fed meeting press conference.
Powell concurred it was good to see a Swiss government-brokered deal with UBS get hammered out in short order on March 19. But that doesn’t mean CS was suffering from the same or even similar issues as some of the mismanaged U.S. regional banks that ignited the recent firestorm of market volatility. In our analysis—and in that of many market participants—CS had a deep cost issue and had been struggling for years from poor risk controls. Lackluster returns in its investment bank were the main culprit, which caused CS to struggle to make money in 2020 and 2021—otherwise bumper years for most capital market-centric banks.
We see the situation that U.S. regional banks face as having minimal translation to non-U.S. banks. That’s the good news.
U.S. regional bank risks are unique to U.S. regional banks
What’s currently unique to U.S. regional banks is that the Fed has used the reverse repurchase (RRP) mechanism to help translate Fed interest-rate policy into actual rates. This has allowed certain banks and money market funds to lend back to the Fed at the RRP rate (slightly below the federal funds rate). The use of this facility has gone from roughly $0 in early 2021 to over $2.1 trillion today. As a result, while so-called “money center” banks such as JPMorgan, Wells Fargo, Bank of America, and a few others still have excess bank reserves, many smaller regional banks have smaller reserves that are back to being tight, as depositors have left in pursuit of higher-yielding money market funds.
This is why U.S. regional banks have been pressured to raise deposit rates to stem deposit outflows. And those banks with longer duration assets that don’t reprice—such as mortgages—have been caught with net interest margin (NIM) compression. Silicon Valley Bank had a particularly acute situation, as it relied on venture capital (VC) deposits and wealthy clients; however, both sources of funding dried up as VC funding slowed and wealthy clients with higher balances sought higher-yielding investments. The bank’s management had also made the poor decision to lock in longer duration securities and loans, which compounded the bank’s problem.
Looking beyond U.S. regional banks: a variety of different potential risks
The one-to-one translation of U.S. bank issues to banks outside the United States isn't something we think we need to worry about. In non-U.S. banks, reserves appear to us to be largely adequate, and banking is more consolidated—even more so now following UBS’ takeover of CS. Furthermore, the spread between deposit rates and the European Central Bank‘s rate of 3.5% is smaller, which reduces the incentive to move deposits. In addition, mortgages are largely structured as floating-rate loans that adjust with changing conditions, so duration mismatches are actually more beneficial to the banks, as NIMs can still expand.
That said, Japan does have some regional banks that could eventually confront losses from higher interest-rate risk, as available-for-sale securities could see negative marks if interest rates were to rise there. But policy rates in Japan have recently been around 0.50% for 10-year Japanese government bonds. That means there would need to be a move higher in rates to trigger any major issues. Additionally, NIMs in Japan are low—typically below 1% (versus 3% for many U.S. regionals)—so there would be upside potential from higher NIMs that could help balance out any mark-to-market security losses.
Where we think non-U.S. banks could see problems emerge is in countries with higher embedded consumer leverage and more credit risk arising from higher rates. Fairly significant housing price booms have occurred in Canada, Austria, and the Nordic countries. This has forced consumers to take out larger loans as a percentage of their income, and those mortgages are largely floating rate. If a floating-rate mortgage rises from 2.5% to 4.5%, the increase could substantially hurt affordability and risk an increase in credit costs. As a result, countries with interest-rate risks tend to burden consumers with credit risks. That’s quite different from U.S. banks, where the risk resides within the banks as duration risk.
Commonwealth Bank of Australia, for example, has already warned that NIMs could shrink this year as the bank struggles to pass on higher rates to many of its customers. In this way, the persistence of higher inflation translating to higher rates for longer could start to create negative issues outside the United States. But problems in such cases are likely to look a lot different from what we’ve seen unfold in some U.S. regional banks—and unlike the situation at CS, which we saw as having fundamental issues largely of its own making.
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