Financial risks after SVB and Credit Suisse—scanning for sources of future instability

The war in Ukraine, high inflation and increasing interest rates were major shocks to both economies and financial markets. Markets had been expecting—or perhaps hoping—for a relatively more stable 2023 after a tumultuous 2022.

They were instead blindsided by the collapse of Silicon Valley Bank and its knock-on effects, including the forced merger of Credit Suisse with UBS in the first quarter of 2023. Central banks and regulators were similarly caught on the hop by these dramatic events. 

There is a consensus view now forming that, following these events, the interest rate tightening cycle may now be nearing its peak. Will we see further monetary policy tightening and more fallout from the interest rate hikes of 2022 and early 2023? Is there more market dislocation and instability on the horizon?

For Asian banks, fund managers and borrowers these are important questions. Even though there has been limited direct fallout in the region, financial markets have been impacted, with increased volatility and tighter liquidity evident.

Repercussions for years to come

Jamie Dimon, chairman and CEO of JP Morgan Chase, is not the type to pull any punches. In his recent letter to shareholders, Dimon wrote: “Risks are abundant, and managing those risks require constant and vigilant scrutiny as the world evolves.” Ominously, he added: “The current crisis is not yet over, and even when it is behind us, there will be repercussions from it for years to come.”  

Jamie Dimon, chairman and CEO, JP Morgan Chase

Fitch Ratings sees an improved outlook in 2023 and 2024, but it is still weak. Fitch recently lowered its global growth forecasts in 2024 to 2.4% from 2.7% “to reflect the lagged impact of rapid Fed and ECB (European Central Bank) interest rate hikes”. 

The impact of higher interest rates is already being seen in the commercial mortgage-backed security (CMBS) and bond markets. It was reported by Bloomberg that in early March 2023, a Blackstone entity defaulted on a Euro 531 million bond backed by a portfolio of offices and stores owned by Finnish company Sponda Oy. 

Dimon noted: “QE (quantitative easing) is now being reversed into QT (quantitative tightening) as the Fed grapples with inflation.” He added: “How all this will unfold is still unknown as the direction and speed of money have changed significantly from prior years.” 

Market watchers are spending increasing amounts of time deciphering Fedspeak as it simultaneously engages in QT and ‘stealth’ QE during this unprecedented moment of crisis. 

Under-regulated industries pose threats

The significant increase in non-bank financial institutions’ (NBFI’s) financial assets in recent years is also seen as another potential area of instability. In its December 2022 report, Global Monitoring Report on Non-Bank Financial Intermediation 2022, the Financial Stability Board (FSB) noted: “The NBFI sector grew by 8.9% in 2021, higher than its five-year average growth of 6.6%, reaching $239.3 trillion.”

Its total share of global financial assets was reported as being 49.2%. The FSB went on to say: “Increases in inflation and interest rates may raise the risk of additional net outflows in open-ended funds and increase credit risk of households and corporates.” 

The rise of the NBFI sector—a fundamentally less regulated sector—is creating new financial risks in the system. As was evidenced by the collapse of the cryptocurrency group FTX in 2022, liquidity issues at these less regulated (or fundamentally unregulated) entities can have far reaching consequences. 

There have been reports already of investment managers limiting withdrawals from office and other commercial real estate funds. The illiquid nature of the asset class sees funds often having to sell properties at lower than the original purchase price. 

The commercial real estate market boomed across many countries under the very loose monetary policies of the last decade. The Bank of England also recently announced the first stress test of the shadow banking sector, amid fears the underregulated industry could put the United Kingdom’s financial stability at risk. The party has clearly come to an end, and this may be one of the sources of future instability.

Many investors, hedge funds, and other market players continue to sit on the side-lines watching the continued impact of higher interest rates. They are cashed up and waiting to pounce on distressed debt and equity situations. 

David Tozer, managing director of Tozer and Co and former partner of investment bank Houlihan Lokey, recently wrote to his investors and commented: "The interest rate hand grenade was launched and is now beginning to explode.” He added: “The intensity of increases in interest rates in a highly indebted world, particularly off such a low base, has caused catastrophic losses on selected securities. The whole system is nursing large unrealised losses.”

Brighter prospects for Asia

The economic and market outlook in Asia is brighter, notwithstanding ongoing geopolitical tensions between China and the US over trade and Taiwan. 

In its recent April 2023 economic update aptly titled Brighter Prospects Amid Ongoing Challenges the Asian Development Bank (ADB) stated: “Growth in the region is forecast to pick up from 4.2% in 2022 to 4.8% in both 2023 and 2024.” 

This was attributed to its report on China in late 2022. ADB was also positive about the inflation outlook, expecting inflation to moderate in 2023 and 2024, falling from 4.4% in 2022 to 4.2% in 2023 and 3.3% in 2024, and “gradually moving closer to pre-pandemic averages”. 

A far better inflation outlook than the US and Europe was expected by ADB in 2023 and 2024. ADB did, however, see the re-opening of China as a potential risk to this favourable inflation outlook. Inflation during 2022 was at elevated levels in many economies before the re-opening of China. 

ADB echoes the concerns of other research groups that the economic stimulus from higher gross domestic product in China may fuel continued, higher levels of inflation well into 2024.

The resilience of many Asian economies—in the face of higher global interest rates and food and energy price shocks—and the financial strength of the sector are again likely to see the region’s banks weather whatever the remainder of 2023 tosses up.

About the Author

Peter Deans is the Creator & Founder of 52 Risks and a leading industry expert on governance and risk management. Peter is also a Non-Executive Director of several organisations and a former Chief Risk Officer.