Why a failed bank is more of a drama than a crisis

There has been a lot of news this month surrounding bank failures, and speculation of a new financial crisis. But the majority of the noise is misinformation. We’re here to set the record straight – a failed bank is more a drama than a crisis.

Negative headlines often cause unease

It’s what they’re for. They keep people reading.

So, when tech-friendly Silicon Valley Bank crumbled, the headline writers didn’t disappoint: “failure”, “incompetence”, “crisis”, and other incendiary words flashed across our screens.

And yet, several weeks later, with the UK arm of this American bank about to join the HSBC group, the financial system remains intact.

Clearly, we don’t know what the future will hold.

The share prices of some banks are moving around more than usual. And in an unrelated incident, the beleaguered Credit Suisse has just been bought by its Swiss rival UBS.

So, are banks in crisis? How bad can things get?

Based on what we know, and if history is any guide, this looks more like a drama than a crisis.

Banks collapse more often than you think

Care to guess how many banks fail each year?

Looking at the market SVB came from (the US) two have already gone this year (Signature Bank and, of course, SVB), four in both 2021 and 2020, eight in 2017, and five in 2016.

The point is, this is not unusual. If anything, 2023 could be a relatively quiet year.

And quiet years tend not to cause financial crises. We know this because, across 2009 and 2010, when the financial crisis was at its peak, some 297 US banks failed.

Proportionately, we’re less than 1% of the way there now.

Banks are different these days…

In the run up to that crisis, it was reasonably normal for banks to use all sorts of creative ways to raise and lend money.

Northern Rock was a good example. They didn’t like the traditional model of taking deposits, using those deposits to offer loans, and pocketing the modest difference between the two interest rates. They got their money from complex, and more lucrative financial markets.

When those markets dried up, as they can do, Northern Rock couldn’t meet its commitments. And it failed.

These days, there are far more rules to mitigate such collapses. Banks have to separate their investment banking and retail deposit taking arms more clearly. If they want to gamble, they can’t do it with your money.

SVB came to an end not because it meddled in complex, esoteric and risky investments. They bought relatively safe bonds but hadn’t sufficiently thought through the impact of rising interest rates.

…And so are the rules that govern them

In the US, the Federal Reserve acted quickly to protect anyone who deposited money with SVB. In the UK, savers were already protected through the Financial Services Compensation Scheme.

After the 2009-10 crisis, The Federal Reserve, Bank of England and other central authorities significantly tightened the rules that govern banks – to minimise the likelihood of a repeat.

Those rules were loosened slightly in recent years (as bankers demanded more room for ‘innovation’) but they’re still far more restrictive than they were 15 years ago.

Now, there’s good reason to expect law makers, regulators and other central authorities to tighten the rules yet further.

Your money

Irrespective of how things play out, the chances are that your investments will be fine over the long run

We may see more banks get into difficulty. We may see a 2020 level of failure (four American banks) or a 2016 level (five).

But even if that happens it’s worth remembering that global stock markets go up about 70% of the time. They did in each of the calendar years 2016 and 2020.

And they also went up in 2009 and 2010 too.

Again, we don’t have a crystal ball but it’s worth remembering that the failure of poorly run companies is a persistent feature of capitalism. They fall by the wayside as better-managed – and more profitable – enterprises move forward.

What we’re seeing now, despite the headlines, has all the hallmarks of a drama.

This document is marketing material for a retail audience and does not constitute advice or recommendations. Past performance is not a guide to future performance and may not be repeated. The value of investments and the income from them may go down as well as up and investors may not get back the amount originally invested.