28 March 2023

Bank collapses. Should we be worried?


Throughout history, banks have had problems, and at times (e.g. through much of the 19th century) collapses have been quite common. However, looking at history, it is easy to say that banking difficulties are much more frequent and severe when regulation is lax or non-existent. Poor regulation and supervision are behind most bank failures.


It is no surprise, therefore, that the problems that we are currently witnessing in the United States (US) are caused by poor regulation.

In the US, since a relaxing of the banking regulations in 2018, small banks (those with total assets of less than $250 billion) are regulated differently from large banks. Therein lies a problem.


The big question is whether the problems in the US are systemic and, therefore, more likely to spread and, crucially for most readers, is your money in a bank here in New Zealand safe?


My answer is that I am as sure as I can be that at least our major New Zealand banks are safe (it is very hard for me to make a judgment on the small ones in New Zealand but I suspect they are reasonably strong – depositors should look at credit ratings before investing).  Almost all other countries around the globe have government-guaranteed bank deposits, but although the New Zealand government provided a guarantee as the GFC hit 2009, this was taken off again. There is a plan to have a permanent government guarantee, but progress towards this seems slow.


How it started

The current bank difficulty started when Silicon Valley Bank (SVB) sold about $20 billion of government bonds. These are nice safe investments, but when the regulation of small banks was loosened, SVB was not required to disclose the value of these bonds. When it had to sell them, the bonds sold for $2 billion less than book value, starting a run of depositors who wanted their money back.


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Perhaps the critical part of bank regulation is the amount of equity capital that banks have and where the capital is invested. This was reviewed in New Zealand in 2019, and at the time there was a wrangle between the banks and the regulator (the Reserve Bank of New Zealand).


Conflicting positions

On one side of this scrap were the banks who wanted to avoid being required to hold larger amounts of equity capital tucked safely away – the more they had to hold, the less profitable they were. However, the Reserve Bank was concerned about financial stability and, therefore, cares less about bank profits and more (much more!) about banking as a healthy institution. The banks and the regulator are, therefore, in quite different, conflicting positions.


In 2019 the public good trumped bank profits, and the banks increased the capital that they must hold. I think that we are all a lot better off for this – safe banks are more important than just about anything for the economy.


Banks are regulated on liquidity

Banks are in the tricky position of bringing in relatively short-term deposits but lending that money out long-term. If all depositors wanted their money back on one particular day, a bank would almost certainly be unable to pay – and it would fold. A run on a bank is every banker’s nightmare; runs on banks are brought about by a short-term loss of confidence. A run can quickly spell doom even if the bank’s finances are reasonably healthy – enough depositors running to the bank to withdraw their savings spells the end.


The Reserve Bank has policies for liquidity and monitors this carefully – a bank has to have enough ready cash and very short-term investments to pay out a reasonable amount of depositors who want to be paid. This costs the banks. They make a lot less money holding short-term investments than they do lending out long-term to customers. Hence the regulator needs to stand firm to require reasonable amounts of liquidity.


The bigger picture

I think it’s fair to say that the Reserve Bank is a very good, firm regulator and is awake to potential banking problems. In New Zealand there has been no sign of relaxed regulation as there has been in the US.


Unlike the US, we no longer have a plethora of small banks as we did before the finance company debacle. These finance companies were effectively small banks and were loosely regulated – they were a disaster waiting to happen.


Project your retirement income.

I think there will probably be more small banks failing in the US and that these failures may have an economic impact in some regions of the US. However, everything I read suggests that the small bank failures are unlikely to affect the larger, better-regulated banks in the US and even less likely to affect New Zealand banks. I will continue to keep my money in a New Zealand bank – and I will still sleep at night.


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Written by:

Martin Hawes

Martin Hawes is not a Financial Adviser or a Financial Advice Provider, and the views in this article are not intended to be financial advice. The views and opinions are general in nature, and may not be relevant to an individual’s circumstances. Before making any investment, insurance or other financial decisions, you should consult a professional financial adviser. Martin Hawes is a director and shareholder in Lifetime Income.

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