why Australia and New Zealand are safe from 'bank run' contagion

There has been a lot of talk about the risk of financial contagion following the collapse of California’s Silicon Valley Bank^[1]. Perhaps too much talk.

While the frequency of bank runs^[2] in the past shows the power of emotions to move markets, there’s little reason to panic.

We’re not looking at anything like the circumstances that precipitated the global financial crisis of 2008. If you’ve got your savings in any bank or credit union in Australia or New Zealand, the greatest fear is fear itself.

Just two other US banks, the New York-based Signature Bank^[3] and First Republic^[4] in San Francisco, have been caught up in the trouble. Internationally, the only casualty is Credit Suisse in Switzerland, whose customers have been saved by loans offered from Switzerland’s central bank and takeover by Switzerland’s largest bank, UBS^[5].

It is likely that until a few weeks ago you’d never heard of Silicon Valley Bank (or Signature or First Republic). But Credit Suisse, founded in 1856, is known around the world. It was regarded as one of 30 systemically important global banks^[6].

What does its troubles have to do with Silicon Valley Bank? Not much, except that fear is contagious, and the bank already had problems that made it extra susceptible to panic.

Interest rates and bond debts

Apart from fear, the one common factor in these bank failures is the impact of higher interest rates on government bonds.

Bonds are a form of debt. Governments issue them to raise money in excess of their tax revenue. Bond buyers are paid regular fixed interest (known as a “coupon”) until the bond matures, when the issuer repays what the original buyer paid for the bond.

Banks like bonds, particularly in uncertain times. Even though they pay less interest than on other forms of debt, there’s an extremely low risk of default. Governments rarely go broke. They can always raise funds through taxation, or issuing more bonds, to meet their obligations.

Read more: We've just sold $15 billion 31-year bonds. What's a bond?^[7]

In the early months of COVID, as central banks slashed interest rates as much as possible to sustain economic activity, the already low rate of interest that governments paid on bonds dropped further. In some cases this meant bond yields were even negative^[8]. But they were still attractive to banks because of the low default risk compared to, say, lending money to companies facing tough times.

Reserve Bank of Australia^[9] But then came 2022 and unexpected inflation, as economies recovered and Russia’s war on Ukraine pushed up global energy prices. In response, central banks began quickly pushing up interest rates. Bond interest rates rose too. The interest rate on a ten-year US treasury bond, for example, was about 1.5% in November 2021^[10]. A year later it was more than 4%. These higher yields on new bonds have lowered the value of existing bonds^[11] that pay less interest. Any bank wanting to sell those bonds (on a secondary market) must do so for less than what it paid. What happened with Silicon Valley Bank This is what happened with Silicon Valley Bank. The early stages of the pandemic were great for it. Deposits by customers, concentrated in northern California’s high-tech industry, tripled^[12]. The bank then invested heavily in US government bonds, intending to hold them until they matured. Then came inflation and the tech industry downturn, with many companies announcing layoffs. Customers started drawing down their deposits to pay their bills. To cover those withdrawals, the bank had to sell bonds at a loss. This reduced market confidence in the bank, leading to further withdrawals by depositors worried it might collapse. Fear of a collapse became a self-fulfilling prophecy.

References

1. ^{^} Silicon Valley Bank (theconversation.com)
2. ^{^} bank runs (theconversation.com)
3. ^{^} Signature Bank (theconversation.com)
4. ^{^} First Republic (www.ft.com)
5. ^{^} UBS (www.ft.com)
6. ^{^} 30 systemically important global banks (www.fsb.org)
7. ^{^} We've just sold $15 billion 31-year bonds. What's a bond? (theconversation.com)
8. ^{^} were even negative (theconversation.com)
9. ^{^} Reserve Bank of Australia (www.rba.gov.au)
10. ^{^} 1.5% in November 2021 (ycharts.com)
11. ^{^} value of existing bonds (www.rba.gov.au)
12. ^{^} tripled (www.npr.org)
13. ^{^} poor risk controls (www.ft.com)
14. ^{^} corrupt and criminal clients (www.theguardian.com)
15. ^{^} cocaine trafficker (www.reuters.com)
16. ^{^} Saudi National Bank (www.cnbc.com)
17. ^{^} The European Central Bank seems to have got away with raising interest rates in the middle of a banking crisis – here's why (theconversation.com)
18. ^{^} almost a century (www.rba.gov.au)
19. ^{^} haven’t been crises. (www.rba.gov.au)
20. ^{^} Bank of Adelaide faced collapse (www.adelaide.edu.au)
21. ^{^} taken over by the Commonwealth Bank of Australia (www.theage.com.au)
22. ^{^} Worst bank turmoil since 2008 means Federal Reserve is damned if it does and damned if it doesn't in decision over interest rates (theconversation.com)
23. ^{^} Financial Claims Scheme (www.apra.gov.au)
24. ^{^} similar scheme (www.rbnz.govt.nz)