The fear of bank insolvency, which began with the U.S. Silicon Valley Bank (SVB), has spread through Credit Suisse (CS) and reached Germany's largest investment bank, Deutsche Bank. The high-intensity tightening that rapidly unfolded since last year has exposed cracks in the financial system, raising warnings that risks could transfer to another pillar of the economy. As the fear of bank insolvency spreads rapidly like the COVID-19 pandemic, striking the world with a 'Bankdemic' (a portmanteau of bank and pandemic), the increase in uninsured deposits and the domino insolvency of commercial real estate and private equity assets are being identified as new epicenters of crisis.
Surge in Uninsured Deposits...A Crisis Trigger
During the COVID-19 pandemic, individuals and companies locked up some of the abundant liquidity in bank deposits, accumulating over $2.3 trillion (approximately 3,000 trillion KRW) in deposits from 2020 to 2021. In this process, the amount of uninsured deposits exceeding the U.S. Federal Deposit Insurance Corporation (FDIC) coverage limit of $250,000 also increased significantly. According to an FDIC report obtained by The Wall Street Journal (WSJ), the amount of uninsured deposits not covered by deposit protection reached about $8 trillion (1,398 trillion KRW) as of the end of last year. This represents a sharp increase of about 41% compared to the end of 2019.
The problem is that, as seen in the earlier SVB incident, the real crisis can begin the moment individuals or companies holding large sums above the deposit insurance limit start mass withdrawals (bank runs) at signs of trouble. The current banking crisis, which began with the SVB bankruptcy, occurred without major insolvencies threatening soundness. The fear of insolvency spread rapidly like a pandemic and was highly contagious. According to a joint paper published by the University of Southern California, Northwestern University, Columbia University, and Stanford University, if only half of uninsured depositors withdraw their money, about 200 banks could be exposed to bankruptcy risk.
Banks that invested massive deposits have seen unrealized losses on held bonds surge sharply due to inflation and interest rate hikes that rapidly unfolded since last year. Like SVB, U.S. banks concentrated pandemic-era surging deposits into mortgage-backed securities (MBS). As of the end of last year, banks' MBS investments amounted to $2.8 trillion, accounting for more than half (53%) of total securities investments.
However, with interest rates rising sharply since last year, MBS prices plummeted, and unrealized losses borne by banks began to surge. Unrealized losses from the MBS sector due to price declines are estimated to reach $368 billion. The problem is that, as in the earlier SVB incident, if liquidity crises occur in small and medium-sized banks, the financial market turmoil caused by MBS fire sales is inevitable. Some banks may urgently sell held MBS to secure liquidity, further driving down MBS prices and acting as a fuse for the crisis.
Asset Deterioration Including Commercial Real Estate Loans
Concerns about contagion of crisis to banks with high proportions of commercial real estate loans, despite sound financial health like Deutsche Bank shaken by the Bankdemic, are also growing. The stock plunge of Deutsche Bank following the full write-down of CS's CoCo bonds (AT1) is a typical sign showing that fears of asset deterioration such as commercial real estate loans are spreading. Although non-performing assets are latent risks, the irrational market conditions caught in the Bankdemic could push the situation toward another bank run crisis at any time, making it threatening.
In particular, small banks with relatively high proportions of commercial real estate loans to total assets are being identified as new epicenters of crisis. For small banks, commercial real estate loans amount to $2.3 trillion, accounting for 80% of total loans. Due to the spread of remote work during the pandemic and concerns about economic recession, the vacancy rate of commercial real estate remains at the highest level since the 2008 global financial crisis. FDIC Chairman Martin Gruenberg warned, "If the situation of low returns and high funding costs in office real estate continues, commercial real estate loan defaults could lead to bank insolvencies," adding, "It is an area requiring continuous supervision." Global integrated real estate services firm CBRE expects office real estate vacancy rates to continue rising through 2024.
Private Equity Investment Fund Deterioration
The WSJ pointed out that private equity and the high-yield bond market could become black holes that increase the level of risk in the global financial system. Following the collapse of SVB and the domino effect causing European banks like CS to fall, illiquid investment funds such as private equity could be the next target. According to McKinsey, assets flowing into the private market have increased significantly since the pandemic, with private equity assets under management reaching $11.7 trillion as of the end of June last year.
Although economic experts and authorities generally analyze that the current fear of bank insolvency is unlikely to spread into a crisis across the entire financial sector, WSJ noted that the 'ghost of financial sector credit tightening' is indeed heightening risks to global economic growth. As of the end of last year, U.S. banks held a total of $17.5 trillion in loans and bonds but had total assets of only about $2 trillion. Philip Schnabl, a professor at New York University's Stern School of Business, estimated that unrealized losses for U.S. banks amount to $1.7 trillion. Eswar Prasad, a professor of trade policy and economics at Cornell University, expressed concern, saying, "The global economy is facing potential risks," and "The ripple effects of the Bankdemic could spread to the global economy."
© The Asia Business Daily(www.asiae.co.kr). All rights reserved.
