Stop guessing if this is a Banking Crisis!
An evidence-based framework to determine if this is a systemic banking crisis
Two key questions determine the outcome of the current banking turmoil. First, do recent events qualify as a ‘systemic banking crisis?’ And second, if the answer to the first question is ‘yes,’ are policy interventions significant enough to end it?
During times of elevated uncertainty – it’s virtually impossible to have any conviction on whether First Republic Bank will make it – it’s crucial to put things into the ‘right’ perspective. Especially with so many (self-proclaimed) pundits sharing their uninformed views.
Laeven and Valencia (2012, 2018, 2020) provide the leading database of banking crises going back to 1970. They identify a total of 151 banking crises over the period 1970–2017.
Their work is consistent and empirically sound, giving an insightful overview of the (common) policy responses we have witnessed over time.
The definition of a systemic banking crisis
Laeven and Valencia define a banking crisis as systemic when two conditions are met:
Significant signs of financial distress in the banking system (as indicated by significant bank runs, losses in the banking system, and/or bank liquidations.)
Significant banking policy intervention measures in response to significant losses in the banking system.
I put a poll out on Twitter and LinkedIn asking if these two conditions are currently met. And the first results (the poll is ongoing) reveal the jury is still out. On Twitter, 58% responded that both conditions are met, against 52% on LinkedIn. This outcome is one (of many) reasons why equity markets have held up so well despite the banking sector issues spreading.
Concerning the first, I think this condition has been met. Bank runs caused the swift collapse of Signature Bank and Silicon Valley Bank, the 2nd and 3rd biggest bank failures in US history.
This chart from the Federal Deposit Insurance Corporation (FDIC) website reveals that while there have been only two failures in 2023 – the FDIC does not count Silvergate’ Bank’ as a bank failure – the volume of the assets involved, USD 319 billion, is strikingly close to that linked to the 25 banks that failed in 2008. And it’s almost double the assets linked to the 140 banks that failed in 2009. These numbers exclude the Credit Suisse – UBS deal, which will likely go down as an ‘acquisition’ despite CS failing as well. Based on the Q4 numbers, CS’s balance sheet held CHF 233 billion (USD 252 billion) in deposits.
In addition, this now well-known chart from FDIC shows US banks have massive (paper) losses on the securities they bought with their deposits. As recently as March 6, FDIC Chairman Martin Gruenberg stated that ‘the current interest rate environment has had dramatic effects on the profitability and risk profile of banks’ funding and investment strategies.’ And he added, ‘Unrealized losses on securities have meaningfully reduced the reported equity capital of the banking industry.’ Hence, the criteria for significant banking system losses has also been met.
The second condition – significant banking policy intervention – likely divides the poll respondents. What makes policy intervention significant? Laeven and Valencia (2012) ‘consider policy interventions in the banking sector to be significant if at least three out of the following six measures have been used:’
extensive liquidity support (5 percent of deposits and liabilities to nonresidents)
bank restructuring gross costs (at least 3 percent of GDP)
significant bank nationalizations
significant guarantees put in place
significant asset purchases (at least 5 percent of GDP)
deposit freezes and/or bank holidays.