Understanding the Mechanics of a Banking Crisis

Understanding the Mechanics of a Banking Crisis

Understanding the Mechanics of a Banking Crisis

A banking crisis can manifest in diverse ways and develop over time, ultimately spreading beyond borders. 

It is often associated with one or more of the following traits: significant changes in credit volume and asset prices; severe disruptions in financial intermediation and the supply of external financing to various economic actors. Financial crises demand prompt and extensive policy measures, may necessitate significant modifications to financial sector and fiscal policies, and require global policy coordination to address effectively.

In March 2008, the Federal Reserve Bank of New York provided a credit facility to Bear Stearns as part of its role in market monitoring.

The bank eventually went bankrupt. This event preceded the collapse of Lehman Brothers six months later, which marked the start of the global financial crisis.

Banking is a complex activity that involves a variety of risks, such as liquidity risk, credit risk, and interest rate risk, among others. Therefore, managing these risks is critical for banks. Silicon Valley Bank (SVB) made some errors by focusing solely on liquidity risk in accounting terms while neglecting interest rate risk and failing to hedge against interest rate fluctuations.

The intricacies of financial institutions make it difficult to comprehend banking crises. While a bank run may be visible, the root causes are often a blend of regulatory mandates, accounting frameworks, tax treatments, and macro conditions. Understanding these underlying factors is crucial to comprehend the full picture of a banking crisis. SVB's missteps illustrate that the mechanics of a bank run have changed because of social media and the ability to make instant digital bank transfers, and therefore the importance of a twenty-first-century comprehensive approach to risk management in the banking industry.

The mechanics of a banking crisis can be complicated, but in general, it involves a combination of factors that lead to a loss of confidence in the banking system, resulting in a run on the banks and widespread liquidity shortages.

Excessive risk-taking by banks and financial institutions is one of the primary causes of a banking crisis. This can happen when banks lend too much money to untrustworthy borrowers or invest in overpriced assets. When these risky loans or assets default, banks can suffer significant losses and lose confidence among depositors and investors.

Credit Suisse's issues also show that international taxation concerns have contributed to the bank's current struggles. The Foreign Account Tax Compliance Act (FATCA), which requires American citizens and residents to disclose their foreign assets, has eliminated the secrecy privilege. Foreign financial institutions must provide detailed information about American citizens' accounts or face sanctions. In 2018, the EU and Switzerland agreed to automatically exchange information on each other's residents' bank accounts. As a result of these measures, the competitive advantage of banking secrecy practices has diminished (Banking Secrecy Act in 1934), and financial institutions such as Credit Suisse have struggled to adapt their business models to the new regulatory landscape.

Despite some investor concerns, the current situation does not yet technically qualify as a financial crisis. However, growing concerns about the sector's fragility and its potential to destabilize the entire economy are becoming increasingly apparent.

With growing concerns about the sector's vulnerabilities, it's vital that regulatory bodies take action to address these risks before they lead to another crisis.

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Mohamed Filali

Global Economy Expert
Mohamed Filali is the founder and managing director of Jurisfiscal, a firm that specialises in the intersection of law and economics, with a particular focus on the relationship between global geo-economic events and corporate taxation. His extensive international experience, including living and working in Spain, U.S., Mauritania, and the UK, has given him a thorough understanding of the economic and legal intricacies of diverse regions. His expertise in global macroeconomics and international business law, as well as my proficiency in analysing large datasets and recognising trends and patterns, have enabled me to gain a comprehensive understanding of the driving forces behind economic events. He is also experienced in sharing his knowledge and insights with the wider public through various media outlets. This experience has honed his communication and presentation skills, allowing him to effectively convey complex economic concepts to a lay audience. In addition, his ability to work effectively in teams and fluency in Spanish, French, Arabic, and English, makes him a value-added for clients and colleagues.
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