HUB EXCLUSIVES PANEL DISCUSSION 2023 – TURBULENT MARKETS: THE IMPACT OF BANKING FRAGILITY
Panel discussion, hosted by Cherry Reynard, with:
Hilary Blandy – Investment Manager, Jupiter Asset Management
Edward Harrold – Investment Director, Capital Group
Connor Godsell – Investment Analyst, abrdn
It has been a volatile period for bond markets following the collapse of Silicon Valley Bank and the turmoil in the banking sector. While few are predicting a re-run of the credit crisis, there are longer-term implications for interest rates, for bank lending and for business and consumer confidence.
- Turmoil in the banking sector is creating volatility, but few fund managers are predicting a re-run of the Global Financial Crisis.
- The regulatory response has been fast, decisive and globally coordinated
- There are likely to be longer-term impacts for bank lending, interest rates and confidence
Turmoil in the banking sector has created significant volatility across bond markets in recent weeks. While the emergency rescue deal between Credit Suisse and UBS plus reassurances from central banks appears to have calmed investor nerves in the short-term, there are likely to be some broader ramifications from the crisis.
The crisis is still playing out, but few fund managers are predicting a re-run of the Global Financial Crisis. Ed Harrold, investment director, fixed income at Capital Group, says there are a number of factors that mark it out from the credit crisis: “It is in its very early stages and may evolve from here, but it is worth noting that it is largely a liquidity and confidence issue, rather than a problem with the quality of assets on bank balance sheets as it was in the financial crisis. European banks are in a position of strength and look robust. Capital ratios and liquidity are far higher than in the financial crisis and banks are also far more profitable.”
Another difference, he says, has been the regulatory response, which has been faster, more decisive and globally coordinated than during the global financial crisis. This has avoided the lingering uncertainty that allowed the crisis to build in 2007-2008.
Each failure had its own idiosyncrasies. Silicon Valley Bank, for example, was uniquely exposed to the technology sector and had significant amounts of uninsured deposits. Credit Suisse had not been well-managed. Hilary Blandy, investment manager, fixed income at Jupiter Asset Management, says: “It had various problems in different parts of the business and been caught up in a number of scandals. It faced a huge loss in confidence, sparked by comments from its largest shareholder. It was essentially a bank run.”
Economic consequences
While the current problems may not be a re-run of the banking crisis, they could still have longer term economic ramifications. Harrold points out that the Federal Reserve has already said it considers the crisis to create the equivalent of monetary tightening. He adds: “It may be that fewer interest rates hikes are needed in future. There may be less money flowing, which may have an impact on growth and a deflationary effect. It may reduce confidence in the corporate sector and for the consumer.”
He believes it may increase the probability of recession this year, adding: “The Fed and Bank of England have proceeded with rate hikes as planned, but the big change has been in future interest rate expectations. For the UK and Europe, we may see one or two hikes from here, but they will be much more conditional on data and financial stability.”
Connor Godsell, investment analyst, fixed income at abrdn, agrees: “Banks will have to pass through higher cost of funding, which gives a higher risk of recession. The areas likely to see the biggest impact are consumer spending, business investment and consumer home loans. The outlook for the real economy is worse that it was, but we are coming into it from a position of reasonable strength.”
The impact of the banking problems may be particularly acute in the US, where regional banks are an important part of residential and commercial property loans and business funding. These regional banks are under pressure. Blandy says: “They are victims of a much bigger trend playing out in the US. While the Fed has raised rates from 0.5% to 5% over the past year, the banks haven’t kept pace on their deposit rates. Customers have switched to money market funds paying higher rates. A lot of money has left the banking system and is moving into money market funds.”
“The other problem is lack of confidence. As a customer of a regional bank, you might have deposits that are much higher than the insured limit. Why would you stay at a bank where there is a risk rather than move to one of the big four in the US?” She believes this will ultimately affect their propensity to lend.
In Europe, the problems are less acute. Blandy points out that European banks have a different accounting regime and are not sitting on large mark-to-market losses. As such, they are much more stable. She adds: “That said, if weaker sentiment persists, it will have an effect on their cost of capital. It will become more expensive for them to raise debt and more difficult to issue equity. That will affect their appetite to lend.”
The co-co problem
Bond markets have also been hit by the specific structure of the UBS/Credit Suisse deal, which saw the group’s ‘CoCo’ (contingent convertible) bonds written down to zero. This was controversial and turned the accepted principle of creditors ranking above shareholders on its head. Blandy says: “It prompted a big sell-off in the CoCos markets, which was down 9% on the day. The ECB and Bank of England said co-cos should rank ahead of equities, which calmed markets. Nevertheless, it has seen investors pull money out of CoCos, which have been an important source of capital for banks.”
Godsell is hopeful that the situation should blow over and resolve itself. However, the greatest risk is that it doesn’t resolve quickly enough. “If regulators can’t get a handle on it, it will have a massive impact on the wider economy”. It shouldn’t be a credit crisis 2.0, but confidence is fragile.
