Bigger than Barings: banking crises have been averted, but how safe is your capital?

Amid systemic failures and fear of contagion, authorities have acted quickly and sought to protect depositors
But the challenge remains to ensure moral hazard, such that the people who make financial mistakes pay the price

Richard Harris

Published: 9:30pm, 6 Apr 2023

Why you can trust SCMP

On the morning of February 26, 1995, I was awoken in a Swiss mountain lodge by the BBC World Service news on my Sony shortwave radio. The signal was indistinct (this was pre-digital) and I gleaned through the ether that a famous British bank had gone bust – but I could not catch the name. I had to wait 30 minutes for the headlines, and a clearer signal, to hear that the 233-year-old Barings Bank had gone under.

The collapse of Barings was very different to the recent banking crises in Europe, the UK and the US. It had sustained losses of over US$2 billion in today’s terms, a derisory amount compared to the US$54 billion that Credit Suisse went around borrowing to try and save itself last month.

Barings suffered from a lack of controls that allowed a rogue trader to build up a massive loss. The authorities avoided the issue becoming systemic or contagious for the financial system by managing a takeover of the remaining assets by the Dutch ING Bank.

Silicon Valley Bank is a niche financial institution that was rescued by the US authorities last month but was much bigger, if less famous, than Barings. It held the assets of many of the private equity technology industry’s start-up companies. Management’s mistake – and an obvious one – was to back its assets with volatile long-dated US Treasuries in a time of rapidly rising interest rates.

Treasuries are a fine investment in the right circumstances; but, as rates went up, the value of those bonds went down accordingly. The (mostly) very rich depositors, on merely hearing of the hole in the balance sheet, wanted all their money back immediately. The US Treasury caved in to support these very rich depositors with Uncle Sam Inc’s balance sheet.

The really serious thread running through the bank failure was the possibility that there may be other careless, unhedged, schoolboy-like bankers out there who might also be holding too many Treasuries in their portfolios. This thread meant the SVB collapse was systemic and might infect the rest of the banking system, unlike the Baring’s crash.

Just as water erodes the weak points of a rock, the fear of failure flowed through the global banking system. Credit Suisse was ripe for attack, having been hit by a series of billion-dollar losses in recent years, due largely to poor management. The request for US$54 billon of support highlighted an urgent need to recapitalise, reinforced by a major supporter, the Saudi National Bank, refusing to sink more cash in.

Credit Suisse headquarters in Zurich, Switzerland, on March 19. Investors panicked after major shareholder Saudi National Bank said it would not inject more money into the Swiss bank. Switzerland’s central bank later stepped in with a credit lifeline. Photo: EPA-EFE

This was a signal for depositors to line up to get their money back – these days through a few clicks on a computer screen. The Swiss authorities had to step in and arrange a takeover by Credit Suisse’s nemesis, UBS.

The one positive theme running through these failures is that the various authorities acted quickly to deal with the problems. The leaks were plugged before the dam burst, even if each failure uses up a little more of the regulators’ financial ammunition and reputation. It gives other financial institutions time to ensure their capital is secure and to learn from the mistakes of others.

The stock markets have taken the collapses well, unhealthily taking the view that big government will support them in a crisis. The nature of the business is that each bank has close links with other banks and, if one goes down, there is a chance that others will too. Banking is a confidence trick, but governments have to support banks – even those badly run by profligate, avaricious incompetents.

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It is an industry that has brought the world out of poverty and is vital to society. Confidence must be preserved, even if rich people are the biggest beneficiaries in a rescue, because it is the ordinary person with a few thousand in the bank who stands to lose most.

The challenge for the authorities is to ensure moral hazard, such that the people who make financial mistakes pay the price – and not the small bank account holder who has few resources and an even smaller voice. That is why many countries guarantee the deposits for their nationals up to a certain level.

Silicon Valley Bank customers eat doughnuts provided by Federal Deposit Insurance Corporation representatives while waiting to withdraw money at the bank’s headquarters in Santa Clara, California, on March 13. Photo: AFP

In both cases, the authorities sought to protect the depositors – including bailing out the very rich. Investors in the bank itself, such as shareholders and low-status bondholders have rightly been left with little – something that is likely to provide a very good living for litigation lawyers soon.

The Baring’s crash taught me that investors can lose money when bonds fall, and they are likely to lose more if equities fall, but you can lose all your money if you have cash in the wrong bank. However, at the moment, it seems that the authorities will bail out small to medium-sized depositors – so your capital should be safe in the bank, even as inflation is likely to cheapen it.

All savers believe they must have the choice to lose, spend or give away their money in the way they want – not lose it in someone else’s scandal. As billionaire financier and philanthropist Dan Gilbert said: “Anyone who dies with money in their bank account is a failure.”

Richard Harris is chief executive of Port Shelter Investment and is a veteran investment manager, banker, writer and broadcaster, and financial expert witness

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