The global financial system remains brittle, but steps can be taken to make it more resilient, writes Malik Sarwar
The global financial system has always been anchored in trust. However, recent banking ‘hiccups’ experienced by Silicon Valley Bank and Credit Suisse demonstrate the fragility of the capitalist financial system, despite its fundamentals of growth. It is important to explore these key events and identify why the global financial system remains brittle. We also need to decide what can be done to make it more resilient.
Historically, banking in the US was local or regional, because each locality, region or state had different needs and depositor-borrower dynamics. Before the advent of online banking, a small banking crisis could be contained without risk of contagion. There were more than 30,000 banks in the US in 1921, reduced to 8,000 in 2000 and now to around 4,000 banks. The reduction has come mainly from voluntary mergers and failures.
March of the Grey Rhinos
Before the SVB and Credit Suisse episodes, there were three Grey Rhino (known-unknown) events resonating worldwide: invasion, inflation and interest rates. Now, there is the fourth ‘I’, namely implosions within the global banking industry.
SVB, a 40-year-old bank, went down in 40 days. The darling of Silicon Valley, heavily touted as the stock to buy by the US financial media including CNBC, was undone by its VC friends. While everyone was focused on low credit risk, they missed the asset-liability mismatch risk as rates shot up the fastest since 1980. Regulators reneged on responsibilities and moved swiftly after the fact to provide guarantees to avoid contagion. Blaming the 2018 loosening of regulations for regional banks is an unacceptable excuse. When SVB failed in March 2023, all eyes were focused on the possible domino effect on the vast US banking system.
Then Credit Suisse started tanking, raising the question of whether this was the advent of the next global financial crisis. Rapid unravelling, due to a litany of investment banking mistakes, showed the moral and professional weakness in top management. While the wealth management business remained strong, contagion resulted in massive client and talent outflow. When SNB-Saudi National Bank correctly backed-off from throwing more good money after bad, SNB-Swiss National Bank had to step in. It was cheeky of the Swiss to expect the Saudis to provide more money instead of doing their part. In the end, they were caught holding the bag, providing poetic justice.
Why did these events take place, and were they isolated incidents? The answer is a definite no. Financial history shows the same three moral and professional failures of leadership: greed, hubris, and lack of policy/operational risk management, combining with devastating consequences. These are common to the demise of FTX and Lehman Brothers, plus caused serious problems at several major Wall Street players.
FTX had a leader in Sam Bankman-Fried with the charisma of a pied piper, sucking in the likes of Sequoia, BlackRock and Temasek. Citi was bailed as “too big to fail” after the boss boasted he was “still dancing” while the music played. And Goldman Sachs, “doing God’s work” as a former CEO quipped, was forced to become a bank holding company to survive.
Impossible to avoid
The hardest question is how to avoid crises like these in the first place. The short answer is you cannot. The only thing that can be done is dial down the probability of the next crisis. There are two things which US and other Western governments, banks, leaders and regulators can implement.
Firstly, they must recognise structural reasons for these flare-ups. Banks were built to be ‘utilities’ for the whole economy, the blood coursing through the veins of the economic body. This necessitates that they don’t risk depositors’ money or shareholders’ equity in leveraged, illiquid investments and trading. Whereas the Volker rule reduced the powers to speculate using the balance sheet, this needs to be reviewed.
A good starting point involves evaluating progress since the 2008 financial crisis. Risk and compliance jobs were created in droves, becoming the true growth sectors within banking. With all this internal and external oversight, why do these issues continue to raise their heads?
Secondly, the greed and hubris displayed by leaders in financial services - though by no means limited to this industry – must be addressed. When CEOs cause loss of money and workers get laid-off, impacting livelihoods of innocent staff, the punishment is not commensurate with the crime. They have been “too big to jail” and typically win a multi-million package on their way out.
This incentivises future CEOs to continue taking unnecessary risks, as the upside reward significantly exceeds downside risk. This is a Sharpe Ratio many feel is worth striving for. Most don’t care about their name being sullied, as they go on to join start-ups or set up their own firms. Compensation of CEOs, typically paid millions - unlinked to financial results, share price performance or reputational risks - must be reviewed and not left solely to market forces. There must be tangible risk control metrics to be met. This will strengthen the capitalist financial system and reduce the probability of future Grey Rhino events from occurring.
By Malik Sarwar, senior partner and head of wealth management, Global Leader Group
