It has been a volatile week in global markets. Concerns over the stability of the global banking system emerged after the failure of Silicon Valley Bank in California and Signature Bank in New York, and signs of stress at massive European bank Credit Suisse. Policymakers responded quickly and the situation has stabilized, for now. We discuss this below, and reiterate our confidence in the investment outlook for the Canadian banking industry.

 

History has taught us that some investors, consumers, and businesses find themselves caught in a vulnerable position when financial conditions tighten. This has largely resulted from complacency or dependence on low-cost financing to enhance returns, fund spending and grow profits. This time appears to be no different. Interest rates began their ascent nearly a year ago and the first signs of challenges emerged within the venture capital industry, as some early stage companies saw their access to low cost capital vanish quickly. A surprise then emerged last fall when the Bank of England stepped in to rescue a number of U.K. pension funds that had their bond portfolios marked down meaningfully as a result of higher interest rates and leverage. More drama unfolded over the past week as SVB was shut down as the result of a classic “bank run”, in which an overwhelming number of depositors lost confidence and decided to withdraw their funds.

 

The banks in difficulty this past week shared a combination of attributes: a clientele that was tied to certain industries like venture capital, a disproportionate amount of client deposits that was uninsured and therefore at risk, bank assets that were concentrated in long-dated fixed income securities like government bonds with unrealized losses due to higher interest rates, and less stringent regulation compared to larger banks. These factors ultimately led to the banks’ demise. The situation with Credit Suisse is different. It is significantly bigger and has been plagued by challenges for years.

 

Central banks, governments, and other commercial banks have taken swift action. They announced guarantees of all deposits at the failed U.S. institutions and injected deposits in other banks to shore up confidence in the banking system. In the U.S., a new lending facility was created to allow U.S. banks to exchange securities, such as bonds, for emergency cash. The Swiss National Bank stepped in to lend Credit Suisse sufficient funds to support it for the time being.

 

We believe that the past week’s events have two near-term implications. First, financial conditions are likely to tighten further as banks prioritize liquidity and capital. This will inevitably weigh on growth as some consumers and businesses may have a more difficult time accessing credit. The second implication is that central banks like the U.S. Federal Reserve may think more carefully about future policy moves as they now have to balance the stability of the financial system along with inflation and growth. Despite these new concerns, the European Central Bank raised rates over the past week and markets still expect the U.S. Federal Reserve to do the same next week (March 22, 23).

 

Not surprisingly, shares of Canadian banks have been volatile as they have moved in sympathy with U.S. and global peers. We remain confident in the stability of the Canadian banking industry. Unlike some of the U.S. regional banks, Canadian banks have some key advantages: a deposit, asset, and customer base that are all very well diversified; elevated liquidity positions; and, due to conservative regulations, high capital levels. While heightened regulatory scrutiny over the past few years may have limited the Canadian banks’ profitability, it has left the group better positioned to deal with periods of stress.

 

If you have any questions, please do not hesitate to contact us.

 

Drew M. Pallett LL.B. CFP

Senior Portfolio Manager and Investment Advisor 

RBC Dominion Securities         

Email: drew.pallett@rbc.com

Website: www.pallett.ca