To say it’s been a volatile two weeks for financial markets would be an understatement. What sparked as a liquidity concern for a California tech bank has rapidly spread to fear of a full-on global banking crisis, following the default of an additional US bank and the sell-off of investment giant Credit Suisse.
The turmoil kicked off two Sundays ago when it was announced that the Federal Deposit Insurance Corporation (FDIC) was seizing Silicon Valley Bank, the 16th-largest financial institution in the US. It was the first indication that rising interest rates are indeed causing cracks in the financial system, as the beleaguered bank, which specialized in startup and tech funding, found itself on the wrong side of highly-leveraged bond investments. It announced on March 8th that it had been forced to sell a considerable chunk of its portfolio at a deep loss, and was attempting to rally another $2.25B in capital to shore up. That led to a swift run on the bank, as depositors rushed to pull out their funds.
The FDIC was prompt in its action, shuttering the bank and announcing it would honour all client deposits, which the US Government backstopped with an additional deposit guarantee. At first, markets were soothed that SVB’s downfall would be contained, successfully absorbed by the systems put in place to ward off another financial crisis of the likes of 2008.
But then the default of New York-based Signature Bank on March 12th, followed by a massive liquidity scare and 3B Swiss francs ($3.2B) sell-off of the 167-year-old Credit Suisse last week, caused those jitters to go global.
Bond markets have absorbed historic drops
This has had a steep impact on bank stocks, which fell further on the news Credit Suisse is being bought at a discount, having once been valued at over $90B. Central bank plans – namely the US Federal Reserve – have also been thrown into flux, with analysts now calling for a quarter-point rate hike or rate hold in the Fed’s rate announcement this week, despite persistently strong inflation – an abrupt turnaround from a previously baked-in half-point increase. As a result, bond markets have absorbed historic drops, with two- and five-year yields down 40-basis-points over the course of last week.
The latest news is that several major central banks have announced they are joining forces with “coordinated action” to ensure financial institutions around the world continue to have the liquidity they need to operate, avoiding any credit strain and supply for households and businesses.
In a release from the Fed, it confirms it, along with the Bank of Canada, the Bank of England, the Bank of Japan, the European Central Bank, and the Swiss National Bank, will “improve the swap lines’ effectiveness in providing U.S. dollar funding, [as] the central banks currently offering U.S. dollar operations have agreed to increase the frequency of 7-day maturity operations from weekly to daily.”
“These daily operations will commence on Monday, March 20, 2023, and will continue at least through the end of April,” adds the statement.
The European Central Bank has also announced it will step in to bolster eurozone banks with loans if required.
It’s a lot to take in – and if you’re wondering how instability in the global banking landscape could impact your money, you’re far from alone. While the Canadian banking system is renowned for being one the most stringent in the world, it’s natural to question whether a similar default crisis could unfold north of the border. Let’s take a look at the safeguards currently in place.
Could a similar banking crisis happen in Canada?
We never say never… but a similar banking default is unlikely here for a number of reasons. The first is how Canada’s banking landscape is uniquely homogenous. Unlike in the US, where there are many smaller regional banks across the marketplace, Canada’s main institutions – famously referred to as the Big Six – are absolute titans. As they command the vast majority of Canadian banking market share, they hold enormous amounts of liquidity – not to mention $60B in annual profits – and are very well diversified across various industries, investment types, and market exposure in their own investment holdings.
This allows them to be more conservative with their investments compared to a smaller bank, which is under more pressure to get yield quickly, and may be more likely to pursue a riskier investment strategy – SVB’s main downfall.
In fact, OSFI – Canada’s banking regulator – has very specific requirements for these “too big to fail” banks – officially referred to as “domestic systemically important banks”, or D-SIBs. This includes mandating they maintain a “buffer” of capital – known as the Domestic Stability Buffer – of 3% liquid cash, which is precisely a safeguard for the scenario that befell SVB and Signature.
This buffer is set twice a year, in June and December – but OSFI maintains it can be tweaked if needed. The last time it made an unscheduled change was in the early days of the pandemic, when it slashed the barrier from 2.25% to 1%, to give banks more leeway on the cash they needed to hold.
As OSFI puts it, “The DSB level is set based on financial trends and a range of risks and key vulnerabilities.” This includes the level of debt carried by Canadian households – and in turn their ability to manage financial stress – and likelihood of a recession.
It also takes into account “asset imbalances” such as the housing market, and whether the economy would be vulnerable should those asset prices drop which can in turn “trigger reduced spending and investment and reduce the value of banks’ loan collateral.”
Finally, OSFI looks at “external systemic vulnerabilities”, such as global developments like pandemics (natch), political unrest or other global macroeconomic risk and conflict that could pose threat to the Canadian economy and health of the D-SIBs.
Additional requirements include the likes of the B-20 mortgage guidelines, which encompasses the mortgage stress test, and also specifies criteria for mortgage borrowers, such as maximum debt ratios and income requirements. This is to ensure Canadian mortgage holders can withstand economic shocks and won’t default on their mortgages.
This has been hugely helpful over the past year as that worst-case rate hike scenario did occur. And while Canadian homeowners have absolutely been challenged by rising interest rates, the damage would arguably have been more widespread otherwise. That’s what set us apart during the 2008 financial crisis, and is what protects us now.
In fact, following the news of SVB’s collapse, OSFI announced it is taking additional precautions to ensure Canadian banks aren’t going down the same path. It’s doing this by checking in on lenders’ liquidity – which essentially means how easily they can move cash around – on a daily basis, a tactic they last employed at the height of the initial pandemic lockdowns in 2020.
Canadian deposits covered by the CDIC
On top of the safeguards put in place by OSFI, Canadian bank balances are also largely protected by the Canada Deposit Insurance Corporation (CDIC). This is a federal Crown Corporation that’s fully backed by the Government of Canada, that insures eligible deposits made with its member institutions, for balances up to $100,000. The coverage is free of charge, and is automatically applied to a number of deposit types including:
- joint deposits (savings held in more than one name)
- savings held in trust for another person
- savings held in Registered Retirement Savings Plans (RRSPs)
- savings held in Registered Retirement Income Funds (RRIFs)
- savings held in Tax-Free Savings Accounts (TFSAs)
- money held for paying realty taxes on mortgaged properties
CDIC members include banks, federally-regulated credit units, as well as trust and loan companies.
The bottom line
It’s undoubtedly an uneasy time for banking clients and investors, as the situation continues to evolve on a regular basis. As always, it’s important to gauge whether your personal portfolio and financial plan are designed to suit your personal risk appetite. It’s a great idea to connect with a financial advisor if you aren’t sure, or are looking to reduce your exposure to current market volatility.