Banking Crisis Sparks Uncertainty in European and U.S. Monetary Policy

ANBOUND
4 min readMar 22, 2023

READ MORE ANALYSIS HERE: https://t.me/PublicPolicyThirdChannel

The U.S. banking crisis triggered by the collapse of Silicon Valley Bank (SVB) is intensifying. Despite the Federal Reserve’s new liquidity support program, some banks are experiencing runs and investor sell-offs. Shares of small and medium-sized banks such as First Republic, PacWest, and KeyBank are sliding after rebounding on Tuesday. On 15 March, First Republic stated that it considered several strategic options, including a potential sale. The panic has spread to the European market since Credit Suisse’s earnings flaws were exposed, with shares hitting a record low and market value shrinking by nearly a quarter.

On the same day, the FTSE 100 index fell 3.83%, Germany’s DAX index fell 3.27%, France’s CAC 40 index fell 3.58%, and Italy’s FTSE MIB index fell 4.61%. BNP Paribas, Société Générale, Commerzbank, and Deutsche Bank all recorded sharp declines. Several bank stocks, including Credit Suisse, had to temporarily suspend trading in the morning. Bank stocks in the U.S. also fell sharply, with Credit Suisse down 13.94%, Citi 5.44%, Wells Fargo 3.29%, JPMorgan 4.72%, Goldman Sachs 3.09%, and Morgan Stanley 5.09%.

Although SVB is relatively small, it is now considered a “rolling crisis”, with panic spreading like a snowball. A few days ago, Warren Buffett disclosed that he had liquidated the shares of Wells Fargo, making this commercial bank, with nearly USD 2 trillion in assets, the next target of market concern. If the fourth-largest U.S. bank encounters problems, the consequences will be catastrophic, even worse than the financial tsunami caused by the bankruptcy of Lehman Brothers. BlackRock CEO Larry Fink also warned that the SVB may be the first domino to drop, with more institutions to be taken over and closed in the future.

The banking industry has been experiencing a series of collapses and, according to most experts, including ANBOUND, the root cause of increased risk in the banking sector is the tightening monetary policy led by the Fed and global central banks. This means that the collapse of small and medium-sized banks such as SVB is just the tip of the iceberg. In cases of high inflation and high-interest rates, seemingly liquidity risk issues actually contain systemic problems for the entire banking industry’s profitability. This is the reason for the spread of market panic. Although central banks in countries like the U.S. and Switzerland guarantee liquidity support, offering liquidity in the context of high-interest rates does not halt the continued losses of problematic banks. This is the main cause of the sudden deterioration of long-standing problematic banks such as Credit Suisse and Wells Fargo.

The banking crisis has led to uncertainty for the Fed and the European Central Bank (ECB), who were originally clear about the path of interest rate hikes since the beginning of the year. The continued interest rate hikes are exacerbating problems in the banking sector, while high inflation remains a concern. Initially, market institutions expected the Fed to raise interest rates in March by 50 basis points. However, after the banking crisis, the market is now expecting a suspension of the rate hike in March, with some institutions expecting a slower pace of interest rate hikes at 25 basis points. Similarly, in the eurozone, the ECB planned to raise interest rates by 50 basis points in March but it is now caught in a dilemma. Should it continue to maintain credit or suspend interest rate hikes to avoid the collapse of the banking sector? Current market expectations are split evenly at 50%. Barclays predicts that the ECB will most likely raise rates by 25 basis points after its meeting on March 16. This shows that both the European and American central banks face difficult choices. Continuing to raise interest rates may cause more banks to collapse while stopping interest rate hikes is unlikely to solve the inflation problem and may drag the entire economy into a contraction. This policy dilemma is a direct result of the current round of bank meltdowns, with monetary policy now tasked with balancing financial stability and inflation.

Currently, it appears to be a trend that the Fed and the ECB will slow down or even suspend interest rate hikes. Even if the central banks no longer raise interest rates, to avoid a financial crisis brought on by the bursting of the banking sector, they will have to provide mass easing support for problem banks. JPMorgan Chase believes that the Fed’s emergency loan program may inject as much as USD 2 trillion into the U.S. banking system to ease the liquidity crisis. This effectively means that the central bank will have to revert to the previous easing policy. Therefore, regardless of whether the two major central banks continue to raise interest rates in March, their future policy adjustments will be inevitable. European and American monetary policies will have to face a new reversal to fundamentally contain the spread of the banking crisis. However, in doing so, although the risk of a banking crisis can be temporarily resolved in the short term, the long-term risks caused by inflation will continue to accumulate, and the long-term systemic financial risks will worsen. This means that the economies in Europe and the United States, which have been practicing quantitative easing for a long time, will have to bear the painful result and face a pessimistic outlook.

Final analysis conclusion:

Credit Suisse and the shares of European and American banks were sold off, causing the panic triggered by the collapse of Silicon Valley banks to continue to spread and form a domino effect. This situation is making the monetary policies of various central banks face new uncertainty. Therefore, the Federal Reserve and the European Central Bank will have to adjust their tightening policies to seek a balance between financial stability and inflation.

--

--

ANBOUND

ANBOUND is a multinational independent think tank, specializing in public policy research, incl. economy, urban and industry, geopolitical issues. Est. 1993.