The past couple of weeks have been swamped by fears of a banking collapse and runs on deposits – something we hadn’t seen much of since the GFC. It’s strange to quote Lenin in this context, but it seems appropriate, he said, “There are decades when nothing happens; and there are weeks when decades happen”. Fortunately, while we’ve seen problems in the US and Europe, Australia has a well-regulated banking system, and our banks are well-capitalised, strong, and profitable.
Last week’s sell-off in the stock market was led by bank stocks. The panic started with fears that the Silicon Valley Bank (SVB) collapse may be the start of a financial crisis that leads to an economy-wide credit crunch and recession and then moved on to Credit Suisse (CS), formerly a global systemically significant bank, but soon to become a subsidiary of UBS. The most important central bankers are now working together to ensure confidence is restored and panic allayed. Sometimes this works, and the crisis passes, but not always.
As it has done often in the past, the US inverted yield curve has been signalling for many months that the rapid tightening of rates would cause “something to break in the financial system”, and so it has proved.
But it is worth noting that SVB and CS were exceptional cases of risk mismanagement and poor practices that are not widespread. We are unlikely to see significant damage across the overall banking and credit system, although there will probably be a few more casualties ahead. As I noted above, the Australian banks are solid and should not be impacted to any great extent by what has occurred overseas.
The good news is that the financial sector’s strains will convince central bankers to at least slow the pace of tightening. Calm will be restored, even if it means that bond, hybrid, and equity holders have to take losses. In other words, monetary policy is already sufficiently restrictive to engineer a soft or hard landing and suppress inflation. Central bankers know that financial stability is far more important than inflation at this point, and they should pause and let the smoke clear.
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