Does the collapse of one of the largest banks in the USA, the collapse of First Republic Bank, at the very beginning of May 2023 mean that the panic withdrawal of deposits by bank customers continues, that people's confidence levels in the banking sector continue to decline rapidly and that this could consequently lead to the emergence of a new banking and financial crisis? Will the institutional rescue instruments that can be mobilised by financial institutions, the institutional deposit guarantee scheme and the central bank prove sufficient to save all failing banks if many more failures were to occur? Therefore, is the principle still valid in the banking sector that a big one cannot fail regardless of the scale of the financial problems and the number of banks at the same time losing liquidity, going bankrupt and being subject to takeovers by the state and other banks? Can the bail-out mechanism operate almost without limit? Irrespective of the scale of the development of financial problems and the number of banks affected, are deposit guarantee institutions 100 per cent capable of guaranteeing the refinancing of the payout of funds to bank customers on deposits and deposits previously made with banks that have declared insolvency? Regardless of the type of pessimistic scenario of developments in the banking sector, is the informal principle that the big cannot fail still valid?
At the very beginning of May 2023, another bank in the US, i.e. First Republic Bank, declared bankruptcy and was quickly taken over by one of the largest investment banks JP Morgan. Considering the multitude of assets of this bank prior to the bankruptcy, this is the second largest banking bankruptcy in US history. An already classic mechanism for stopping potential customer panic in the banking sector was used, which was that First Republic Bank of San Francisco was first taken over by a state agency and then resold to a larger bank, i.e. JP Morgan. Financial problems at First Republic Bank were already noticeable from mid-March 2023. These problems quickly began to worsen when two smaller mid-sized investment banking formula banks in the US collapsed, i.e. Signature Bank and Silicon Valley Bank. The bankruptcies of these two banks caused panic among bank customers, who began to withdraw their deposits from many other banks, including First Republic. Consequently, the share price of California-based First Republic Bank also collapsed and entered a stock market crash. At the beginning of 2023, First Republic Bank's share price on the stock exchange was still reaching almost USD 150, while at the end of April 2023, the price was already at only a few USD. During just one trading session on Wall Street, First Republic Bank shares fell by around 50 per cent to US$ 8.1.
The withdrawal of deposits and deposits by bank customers has increased the scale of uncertainty in the financial markets and is linked to a decline in citizens' confidence in the banking sector. This issue, together with persistent inflation, prompted the Federal Reserve Bank to raise interest rates for the 10th time in a row to 5.25 per cent, the highest level since 2007, the year in which the global financial crisis of 2007-2009 began. Two days later, the European Central Bank also raised interest rates by 25 basis points for the 7th time in a row. The process of monetary tightening by two of the largest central banks in the context of global financial markets therefore continues in early May 2023. The tightening of monetary policy is aimed at reducing the levels of acceptable investment and credit risk in the context of transactions in financial markets. A negative side effect of this process is the possibility of a significant reduction in the scale of investment realisation in the real economy and a significant decline in the economic activity of firms and companies. In the situation of the development of such a negative scenario, unemployment may significantly increase, the level of repayment of bank loans may decrease, the level of consumption and tax revenues to the state budget may decrease. An additional systemic risk factor is the high level of debt in the state's public finance system. The steadily growing US public debt of USD 32 trillion will reach the statutory debt limit at the end of June 2023. On the other hand, high inflation helps the government in terms of reducing the scale of public debt servicing costs. However, high inflation with high unemployment can, in a situation of deepening downturn, lead to stagflation, i.e. a situation of economic crisis, during which the possibilities of applying anti-crisis state interventionism are limited.
I will write more on this subject in my book, which I am currently writing. In this monograph I will include the results of my ongoing research on this issue. I invite you to join me in scientific cooperation on this issue.
Counting on your opinions, on getting to know your personal opinion, on an honest approach to discussions in scientific problems, and not on ready-made answers generated in ChatGPT, I deliberately used the phrase "in your opinion" in the question.
In view of the above, I address the following question to the esteemed community of scientists and researchers:
Is the informal principle that the big cannot fail still valid in the banking sector?
What is your opinion on this topic?
What is your opinion on this subject?
Please respond,
I invite you all to discuss,
Thank you very much,
Warm regards,
Dariusz Prokopowicz
The informal rule that big banks can't fail derives from the fact that they dominate huge markets. The five largest fx market operators represn=ent 53% of a 7.5 trillion dollars a day market. The situation in the derivative markets is even more stunning. The outstanding derivative market in mid 2022 reached over 630 trillion dollars and 5 banks dominate this market with a 96% share of it.
As these big banks are tightly interlinked, a systemic failure would crush these markets. In view of the amounts involved, no country could rescue the financial system. The only solution is to avoid the failure of these big banks and the domino effect they could create.
In March of this year, the major Swiss bank UBS took over Credit Suisse, Switzerland's second-largest bank, in a rescue operation for three billion francs. In addition, UBS is liable for losses of up to five billion francs. The Swiss National Bank (SNB) is supporting the takeover with liquidity aid of 100 billion francs (around 101 billion euros) to both banks. This is the most significant bank merger in Europe since the financial crisis 15 years ago. This solution was worked out by the two banks as well as top political and supervisory representatives. These orders of magnitude, the commitment of politicians and the central bank show: Yes, the "big can't fail" rule still applies in the banking sector. Whether it can be upheld in the future remains to be seen...
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