The Current Banking Crisis: A Critical Analysis Of The Strategies To Manage Financial Risks – The recent crashes in the financial markets have shaken the global banking industry. This article will discuss the recent financial crashes and their effects on investors and the future of banking, with a particular focus on asset-liability management.
The purchase of UBS by Credit Suisse for $3.2bn, recently, raised serious concerns about the state of global banking. The share deal included extensive government-backed guarantees and liquidity, marking a 99% decline in Credit Suisse’s share price from its peak in 2007.
Following this, there were multi-billion dollar losses with the collapse of investment fund Archegos and Greensill Capital on 15 March. The largest investor in both funds was not willing to extend any more support, thereby declining the company’s share price by 24%. Additionally, the Silicon Valley Bank (SVB), which had $212bn of assets, failed spectacularly on March 10th, making it the biggest lender to collapse since the global financial crisis of 2007-09.
These crashes had significant effects on stock markets, creating a ripple effect, particularly because banking stocks contribute the largest share in the markets. The turmoil in banking stocks also triggered drops in yields for US Treasuries and Eurozone bonds, and gold prices renewed their recent rally as investors sought safe havens. Even the Bitcoin market gained $26 billion, hitting a 9-month high.
So, what led to this crisis point?
The Current Banking Crisis: A Critical Analysis Of The Strategies To Manage Financial Risks – Clearly, the largest contributors were rampant inflation, the after-effects of COVID-19, and the war in Ukraine, which constantly impacted bonds used by banks to manage their liabilities, cash flows, and deposits.
Asset Liability Management: The key strategy to manage risks
The Current Banking Crisis: A Critical Analysis Of The Strategies To Manage Financial Risks – The recent crashes also highlighted the importance of ALM. By loading up on long-term bonds, SVB had taken an enormous unhedged bet on interest rates staying low. This bet went very wrong, making SVB technically insolvent. This resulted in shareholders being wiped out, and bondholders taking big losses. Similarly, depositors became nervous about Signature Bank’s health, owing to its high amount of uninsured deposits as well as its exposure to crypto and other tech-focused lending.
To manage the risk of rising interest rates and inflation, banks typically use ALM. They may choose to hold shorter-term bonds, which are less sensitive to interest rate changes, or they may consider other assets that are less affected by inflation, such as real estate or commodities. Additionally, banks can use interest rate swaps and other financial instruments to hedge against interest rate risk.
ALM involves matching the duration, risk, and cash flows of a bank’s assets and liabilities. Duration matching involves matching the duration of assets and liabilities to reduce interest rate risk, while cash flow matching involves matching the cash flows of assets and liabilities to ensure that the bank has sufficient liquidity. Risk matching involves matching the risk profiles of assets and liabilities to ensure that banks are appropriately compensated for the risks they take. Finally, diversification involves investing in a range of assets and issuing a range of liabilities to spread risk across different categories.
Lessons from the crisis
The Current Banking Crisis: A Critical Analysis Of The Strategies To Manage Financial Risks – The recent financial crashes have highlighted the importance of proper ALM for banks. By matching the duration, risk, and cash flows of assets and liabilities, banks can ensure that they can meet their obligations and maintain liquidity under various economic scenarios. With the right ALM strategies, banks can manage the risk of rising interest rates and inflation, ensuring their long-term sustainability and success.
Hilton Supra is banking and financial management expert with over 30 years of experience in quantitative asset management, capital markets, hedge funds, and private equity. He has always been on the leading edge of innovation in finance, investment, and technology, especially the application of blockchain, AI, Web 3.0, and fintech 360.
Hilton is the co-founder of Zudium Group, a builder of 4IR platforms (using blockchain, AI and IoT data analytics), and its subsiduary companies: techabc limited (citiesabc.com) Open Business Platform Limited (openbusinessescouncil.org), Fashiondna Limited (fashionabc.org).
As a host of the citiesabc YouTube Podcast Series, Hilton has interviewed eminent guests and experts from the fields of innovation, technology, finance, and fashion, including Felix Xu, CEO of ARPA and Bella Protocol, Labid Aziz, CEO of People of Culture Studios, Jesse Brown, CEO of Himalaya Exchange, to name a few. The channel was awarded Silver Badge from Youtube and is amongst the top 1000 tech channels on social blade.