What happened?
Financial markets have been rocked by the downfall of two big banks in recent weeks: Silicon Valley Bank and Credit Suisse. Although the underlying problems of both banks differ significantly, they both constitute the largest bank failures since 2008, and both can be attributed to insufficient risk management. In brief:

• Silicon Valley Bank: SVB invested in long-term assets, to make a profit over their short-term liabilities (e.g. deposits), leading to a significant difference in interest rate sensitivity between assets and liabilities. When interest rates rose quickly, this duration mismatch led to significant losses, making the bank insolvent.
• Credit Suisse: Various scandals at Credit Suisse have been ongoing for multiple years, with a strong underperformance to show for it. The postponement of the annual report earlier this month resulted in a final breakdown of trust in Credit Suisse by investors and initiated a large outflow of funds at the bank, draining the bank's liquidity. In the forced takeover by UBS, some controversy regarding the seniority of subordinated debt (co-cos) vs. equity emerged.

As a result of these failures, investors have been re-assessing their exposure to the banking sector leading to a significant sell-off in markets. Among this turbulence, investors increasingly worry about which bank is next and whether we are at the start of a new global financial crisis such as we had in 2008.

What’s ahead?
Uncertainty around the banking sector has increased overall market unrest. Although there are some parallels to 2008, each new crisis has its own circumstances and consequences. For now, we see the following developments ahead of us:

Central banks face a dilemma
On one hand, central banks are still fighting high inflation. On the other, they have a duty to maintain the stability of the financial system. As SVB has shown, these two objectives can conflict: increases in rates have destabilised the bank, but central banks will be wary to be held hostage by institutions with a bad balance sheet of their own making. Additionally, the stress in the banking system increases recession risks, making it harder for central banks to keep fighting inflation.  Banks with proper risk management should be able to absorb rising interest rates. Given that, we do expect central banks to continue hiking rates to fight inflation, though probably at a slower pace, while keeping a keen eye on growth and financial stability. In such an environment, the risk of overshooting rates by central banks increases, but the 0.25% rate hike by the US Federal Reserve last Wednesday (instead of a 0.5% hike) illustrates that they may be taking a more cautious approach.

Contagion remains limited
The downfalls of SVB and Credit Suisse were not directly connected, but it shows how irrational bank runs can occur, with the potential to hit any bank next. As of now, we see the market testing the resilience of multiple, mostly US regional banks, such as First Republic. Additional capital requirements on banks, additional resolution mechanisms instituted since 2008 and central bank interference have, so far, limited the contagion effect, but several banks could still default in a short time, putting the entire system under stress.

Increased downside risks for the economy
Although we do not foresee a new global financial crisis, we do see the recent developments as increasing some major downside risks for the economy. 

• Any prolonged period of unrest in the financial sector could be the final push for the global economy to enter a recession, with the additional risk of a downward spiral: Increasing interest rates and credits spreads make investments harder for companies, while limited liquidity from banks also makes it harder for companies to weather the storm in case of an economic downturn. As corporate defaults increase, the balance sheets of banks will also be impacted negatively, further limiting liquidity and so on.
   
• US debt crisis: in 2008, governments intervened to rescue several banks. Compared to 2008, the dept-to-GDP ratio of the US Central government has increased significantly. Joined by a divided Congress and a government facing its debt limit, the willingness and ability of the US Government to rescue banks or support the economy in case of a further downturn is limited.

Potential challenges ahead for pension plans
All of this has put pressure on U.S. pension funds, with many experiencing losses on their bond and equity allocations, due to rising rates and choppy markets respectively. If rates increase further, and stock markets decline, funds could be in for a repeat of 2022, when both asset classes were down on the year. There may be some potential upside, however: corporate plans may profit from higher spreads on the liability side because of higher discount rates. 

For our Swiss pension fund clients, the UBS takeover is, naturally, top of mind, especially given the limited number of companies in the Swiss equity market. Fortunately, fund ratios are still above 100%, on average. 

The main takeaway from the recent banking crisis isn’t that assets are volatile – it is that markets can move extremely quickly and it is difficult to know what might happen next. Now it is the time to come up with a plan – or review an existing one – to ensure you are ready for whatever might come next.

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