During times of economic downturn, it is not uncommon for banks to face financial difficulties and even collapse. History indicates that during financial difficulties, even developed countries face bank runs.
For example, the 2008 Financial Crisis caused 25 banks to fail in the US that year. The aftermath of the crisis caused 3,891 more US banks to collapse in the next three consecutive years.
Following the Russia-Ukraine war, the global economy has changed drastically. When the whole world was dealing with energy shortage, price hike, and high inflation, in March 2023, shockingly, three US banks, from Silvergate Bank, followed by Silicon Valley Bank, and Signature bank, all collapsed within just three weeks of time.
The Russia-Ukraine war has an impact on all the countries. Then how is it that Bangladesh, a developing country, has kept its banking sector unharmed in a situation where banks in the US are failing?
US bank collapse
Before moving into any analysis, the reason behind US bank failures needs to be understood.
The first bank that collapsed was Silvergate Bank. The bank was largely involved in dealing with crypto currency. However, in the beginning of March, the bank announced its shutdown.
Once considered a cornerstone in the crypto industry, the bank's downfall was triggered by the fall of one of its largest clients, FTX. This, in turn, led to a bank run as panicked depositors withdrew an astonishing $8.1 billion in just one quarter between October-December last year.
To make matters worse, Silvergate Bank was forced to sell off its assets at a lower price, resulting in a colossal loss of $1bn. The delayed annual report was the final straw, and the bank was forced to shut down on March 8, 2023.
The fallout from Silvergate Bank's collapse has been felt throughout the industry, with high-profile collapses at Silicon Valley Bank (SVB) and Signature Bank due to a severe confidence crisis among depositors in the US.
The story is no different for SVB, a start-up-based bank founded in 1983 in California which rose to become sixteenth largest bank in the US with more than $200bn in assets. SVB had no direct link to cryptocurrency like Silvergate and Signature, but a CNBC report revealed that the crypto firm, Circle, had $3.3bn exposure in the bank.
SVB, long considered the go-to bank for tech start-ups, saw an astonishing rise in deposits, soaring from $62bn in 2020 to a staggering $175bn in 2022. However, the bank made a costly error by committing the classic mistake of "maturity mismatch."
It invested its funds heavily in long-term government bonds, despite the majority of its deposits being short-term in nature. This mismatch left SVB vulnerable to potential liquidity issues, highlighting the importance of proper asset-liability management for financial institutions.
As funding opportunities for tech start-ups began to dwindle in the wake of the Russia-Ukraine conflict-induced economic downturn, many of SVB's depositors began to withdraw their funds. Adding to the bank's woes, the value of its bond portfolio declined due to eight consecutive interest rate hikes by the Fed, which had been near zero the previous year.
In an effort to bolster its finances, SVB announced plans to raise $2.25bn through stock sales. However, the announcement ended up being the final nail in the coffin, triggering a massive bank run and resulting in the largest bank collapse in the US since the 2008 financial crisis, all within a mere 48 hours.
The common features of these collapsed banks were their high exposure to crypto and interest risk, portfolio maturity mismatch, lack of required regulatory check, and most importantly, failure to measure their own “Risk Absorption Capacity.”
The collapses once again revealed the regulatory weakness of the Federal Reserve in failing to formulate any established policy regarding cryptocurrency. Even though it is evident that a major shakeup in the crypto world has left several banks reeling from collapses that started with the failure of Silvergate Bank, the Federal Reserve is still limited to warning the banks of being “careful” in adding too much crypto currency in their balance sheet.
The regulatory body is not even bothered to limit the exposure of banks into a single sector which allows many banks to have extended exposure in highly volatile sectors like crypto.
The Federal Reserve has endeavoured to ameliorate the recurring situation by citing it as “systematic risk” and safeguarding the insured and uninsured depositors exceeding $250,000, except for the shareholders, and uninsured debtholders.
The Federal Deposit Insurance Corporation (FDIC) also transferred the depositors into newly created full-service “bridge banks.” A $25bn lending facility has been created as a backstop to meet the banks' emergency liquidity needs.
However, all these measures have little regained the confidence of depositors, since the Federal Reserve continued to hike its policy rate on March 22 -- its ninth straight hike in a year to combat higher inflation.
Ultimately, how far can the Fed cover up the small tech start-ups -- who have deposits of over $250,000 in a bank -- general depositors, and shareholders of the banks, if the “bank run” contagion spreads to other banks in the country in such a short period of time?
Global impact
The financial sector is highly connected domestically and globally since this sector is run on depositors' trust and confidence in the banks.
According to a study of Social Science Research Network, there are 186 banks across the US that could fail if half of their depositors were to withdraw their funds quickly.
Historically, the large US bank failure impacted the global financial system. For example, the impact of the Lehman Brothers failure was felt across the globe, with the financial markets in Europe, Asia, and the Americas all experiencing significant losses.
In today's world, the whole economy is interlinked. Thus, the failure of banks in one country definitely impacts the banking industry of others. And if banks in a country like the US fails it creates tension among other countries.
Depositors are likely to lose their faith in banks and might start withdrawing their deposits. It will create a situation like a bank run and thus the bank may fail. To avoid bank runs, other economies are focusing more on ensuring a stable economy and formulating policies to survive.
Banking industry of Bangladesh
Currently, Bangladeshi depositors should have less to worry about because the turmoil of the bank collapses in the US and other parts of the world is not expected to affect financial institutions in Bangladesh, due to its “policy differences” with that of the US.
The banking policy of Bangladesh is tailored to its own system which is distinguished, even compared to global banking policies. There are several areas where the banks of Bangladesh differ from that of the US.
Liquidity crisis
In the US there are banks that operate on their own without any branches, which is called the unitary banking system. But In Bangladesh, all the banks have branches all over the country.
The unitary banking system of the US makes it difficult for the banks to absorb extended liquidity needs from the depositors. While US banks hit headlines seeking excess liquidity by selling off assets, Bangladeshi banks can effectively meet extended liquidity needs of one branch with the support of other branches from the same bank. Thus, bank runs are not as scary in Bangladesh as it is for the US banks.
Liquidation procedure
The market-based liquidation sparked the collapse of banks in the US. Whereas, Bangladesh Bank, as per The Banking Company Act 1991, and the government, as per The Financial Institutions Act 1993, can intervene and save a troubled bank through taking corrective measures to safeguard the interests of depositors, stakeholders, and overall economy of the country.
There is a school of economics who suggest that banks should be left to operate on their own. Making it so that only efficient banks survive.
However, if market-based liquidation was allowed in Bangladesh, the shaky corporate governance issues of the banks would hurt the interests of depositors even more. At the end of the day, the depositors are the ultimate losers of a bank collapse or liquidation as banks and the Financial Institution Deposit Protection Act 2022 protects depositors only up to Tk 2 lakhs.
Dealing with inflation
One of the reasons why banks failed was the market interest rate. In the US, the market interest was near to zero. And so, investing in bonds with a low interest was profitable without doubt.
However, the Russia-Ukraine war brought about high inflation all over the globe and the US was not any different. As inflation rose, the US had to increase its policy rate. As bonds have a negative relation with market interest, the value of the bonds declined. This is another factor that worked behind the bank collapse.
However, Bangladesh Bank did a commendable job in raising policy rate in accordance with the needs of managing inflation, and giving “breathing space” for the banks since they did not have to face a shock of interest rate fluctuations. Raising policy rates gradually was a praiseworthy move from Bangladesh Bank.
Investment portfolio
Unlike the US banks, the Bangladeshi banks do not invest in one or two specific sectors. Bangladesh bank has made it necessary for the banks to be diversified in investing its funds through its regulations.
Thus, no bank is allowed to invest only in one specific sector. Rather, they are to maintain an investment portfolio. The only exception to this rule is the specialized bank, set up by the government to facilitate the marginalized section of the society.
Banning crypto
The biggest strength of Bangladesh banking sector comes with the understanding of its own blind sports or Risk Absorption Capacity. Realizing the potential financial risks to the economy, in 2014, Bangladesh was one of the few countries to go against the trend and deny Bitcoin and any other cryptocurrency as legal in line with the Foreign Exchange Regulation Act 1947, and Money Laundering Prevention Act 2012.
Crypto currency is a form of digital currency that doesn't have any assets to back up its value. So, it was prohibited to utilize cryptocurrency, and Bangladesh Bank had issued cautionary advisories as well as detained individuals involved in Bitcoin trading. The prudent decision-making of Bangladesh Bank is now benefitting Bangladesh at the time of global turmoil in banking sectors.
Economists find that the risky practices of crypto-currency trading, which went unchecked by the regulators for the last few years, is equally responsible for the bank failure, other than the Russia-Ukraine war induced economic downturn and higher inflation.
Thus, those who once pointed fingers to the decision of not allowing crypto-currency even though having a goal of becoming “Digital Bangladesh” must have learnt that banning the use of such risky currency was a wise decision.
The ongoing global banking sector turmoil should not concern Bangladesh since the country's banking sector is well-insulated against highly volatile cryptocurrencies. However, the rumours should not be undermined as it is one of the reasons behind bank runs in the collapsed US banks.
The policy makers and banking sector regulators should focus more on building credible and efficient public relationships -- especially on the social media platforms in which the absence of a formal channel creates a vacuum where disinformation misguides depositors -- to alter any ill-motivated rumours that might create panic among general depositors.
Dr Ashraful Alam Chowdhury is an Independent Researcher and Columnist. He completed his MSS in Economics from Dhaka University and PhD in Economics from Emory University, Georgia, USA. He has experience of working in the US, Bangladesh, Myanmar and India.
