SVB collapse attests to fragility of global finance system

London - After years since the 2008 global financial crisis that brought the international financial system to near collapse, banking regulators in key global markets last week were once again dealing with the fallout of the largest failure of a US bank since then.

As if the lessons of the collapse of Lehman Bros that precipitated the 2008 crash have fallen on deaf ears despite the protestations of the G7 countries, the two gatekeepers of the international financial system – the Basle Committee for Banking Regulation and Supervision and its associated Bank for International Settlements, and the Financial Stability Forum of the International Monetary Fund –have failed to make definitive progress made since then.

This despite the emergence of new threats and stresses such as the socio-economic and macroeconomic impacts of the Covid-19 pandemic, the fuel and food supply chain disruptions caused by the Ukraine conflict and subsequent price rises, and the resultant global economic shocks –especially rising inflation and interest rates.

The failure is that of Silicon Valley Bank (SVB), whose US and UK operations saw a run on their money due to lack of liquidity and looming insolvency forcing the Federal Reserve Bank (Fed), The Federal Deposit Insurance Corporation (FDIC) in the US and the Bank of England to shut down then bank and its subsidiaries and to take control of their customer deposits.

The collapse came after SVB unsuccessfully tried to raise $2.25 billion to plug a loss caused by the sale of assets, mainly US Treasury bonds, which had been affected by higher interest rates as the Fed tries to rein in spiralling inflation.

SVB, the 16th-largest bank in the US prior to its collapse a few days ago, was a crucial lender for early-stage businesses and start-ups, and the banking partner for nearly half of US venture-backed technology and health-care companies that listed on stock markets in 2022.

Fortunately, it seems the size of the crisis is not in the same category of the Lehman collapse, with the FDIC swiftly taking control of customer deposits of just over $175bn, which together with prompt action from regulators has dampened any major contagion.

However, the collapse once again attests to the fragility, vulnerability and fickleness of the global financial system, which is supposedly to have been tightened through a cornucopia of stress testing, capital adequacy, deposit protection, reserve requirements, risk management, financial reporting, financial stability and security, anti-money laundering and terrorist financing measures.

It once again raises questions about the state of the global banking industry. In the specific case of South Africa, the banking sector has shown remarkable resilience in the wake of the various uncertainties in the past few years.

The South African banking sector is the most sophisticated on the continent and the largest in terms of assets under management, market depth, product diversification and innovation, albeit it is beholden to a huge chunk of sovereign business and attendant risks.

Moody’s Investors Service, in a report in February, assigned a stable outlook on the South African banking sector on the basis that “sound capital and liquidity buffers, good risk management will shield banks from macro pressures and asset risk”.

On the downside, subdued economic growth, which it forecasts at 1% in 2023 and 1.24% in 2024, will make operating conditions difficult.

Sluggish economic growth, high inflation, rising unemployment, a jump in interest rates and severe power cuts, it observed, will all constrain business growth opportunities and pressure the repayment capacity of some borrowers.

Similarly, asset risk will remain high. Sector-wide non-performing loans stood at 4.6% of the loan book as of November 2022, and will probably rise to around 6% over the outlook period.

Banks also remain heavily exposed to government securities. Moody’s estimates these at 2.3 times the equity of the six commercial banks in South Africa it rates – Standard Bank, First Rand, Absa, Nedbank, Investec and Bidvest bank – which together accounted for around 90% of banking sector assets as September 2022 – which links their credit profiles to that of the Ba2-rated government.

On the positive side, the government’s improved fiscal and revenue forecasts and lower debt trajectory in the recent Budget 2023 will allow it to reprioritise spending and help restore confidence.

This will give the government more ammunition to address future risks.

The rating agency predicts a stable outlook for bank capital; resilient profitability, good funding and liquidity conditions, while a closed-rand system will mitigate risks relating to dependence on wholesale deposits.

Implementation of a new bank resolution regime in progress, following the enactment of the Financial Sector Laws Amendment Bill, will also be positive for banks’ senior creditors.

A recovery in profitability, combined with muted growth in risk weighted assets and moderate dividend payments, has allowed South African banks to build up their capital buffers.

“We expect broadly stable profitability in 2023, with a return on assets of around 1.1%, reflecting some muted revenue growth, digital investment and diligent cost-cutting efforts.

Nevertheless, South African banks can rely on their prudent risk management, improved liquidity and solid capital buffers to weather the tough conditions.”

However, the banks’ performance could be weakened by the “greylisting” of South Africa by the Financial Action Task Force for deficiencies in efforts to combat money laundering and terrorist financing, and climate and social-related events such as floods and social unrest.

There could also be implications for the soundness of the South African financial sector if the mandate of SARB is widened beyond the narrow one of managing monetary policy and inflation.

Some ANC officials, including President Cyril Ramaphosa, would like SARB also to pursue policies to promote employment, growth, investment and economic transformation.

“The very strong credibility of the SARB,” said Jan Friederich, head of EMEA Sovereign Ratings, Fitch Ratings, “is an important strength for South Africa’s creditworthiness that has helped contain financing costs in international markets.

A host of factors is behind this credibility, with the track record probably the most important one.

“It is unlikely that a change in the mandate would immediately lead to a substantially different monetary policy sufficient to require a change in the rating, as it is not clear that an easier monetary policy would support employment, growth or transformation in the long term.

“But changes to the mandate, particularly if combined with other factors, could still have a negative impact on SARB credibility and financing costs.”

Parker is an economist and writer based in London

Cape Times

* The views expressed do not necessarily reflect the views of IOL or Independent Media.