Shares in some of Europe's largest banks plunged on Monday, as the fallout from the collapse of Silicon Valley Bank in the US last week continued to spread.
European banks suffered their worst day on the stock markets in more than a year and the bond market factored in a huge repricing based on new predictions for interest-rate increases.
Europe's bank index lost 6 per cent, having already shed 3.8 per cent on Friday. In London, HSBC shares fell by more than 3 per cent after it said it would acquire the UK subsidiary of SVB for the token amount of £1 ($1.2).
Despite moves by the authorities in the US to make sure the troubles of SVB did not infect the entire banking system, caution remains.
At the weekend, the Federal Reserve and the US Treasury announced a raft of measures to stabilise the banking system and said depositors at SVB would have access to their deposits on Monday.
Meanwhile, memories are being ignited of what happened the last time there was problem with confidence in the banks, which led to a full-blown global financial crisis back in 2008.
While analysts say that today's issues are completely different and far less severe than what happened 15 years ago, they do underline how sensitive the markets are to any problems with banks and the banking system.
“For the moment, the full extent of the SVB issue in Europe appears to be limited, but the news comes at a time of heightened investor uncertainty, amid rising interest rates, persistent inflation, potential downgrades to company earnings and geopolitical tensions”, Richard Hunter, head of markets at Interactive Investor, told The National.
“While it will take some days for the full ramifications to become clear, investors are once bitten, twice shy after the events of the global financial crisis, when the full extent of the interconnectedness of the banking world took some time to unravel into a generational shock.
“There is little to suggest a repeat at present, but in light of the investing backdrop investors are currently choosing to err on the side of caution for now.”
Tom Caddick managing director at Nedgroup Investments, said: “We are seeing a classic flight to safety”.
“Higher interest rates and a slowing economy was always going to bite.”
'Not a specific alert'
Voices encouraging calm came from several quarters, including US President Joe Biden, who reassured Americans that they “can have confidence that the banking system is safe” and that their bank deposits “will be there when you need them.”
French Finance Minister Bruno Le Maire said the problems of SVB were contained and that he did not see any risk of them spreading.
“What happened in the US is very unique, with a bank that is exposed exclusively to the tech sector”, he told France Info radio.
“There is not a specific alert for the French banking sector, and we are of course following the situation very closely.”
Likewise, Italy's Finance Minister Giancarlo Giorgetti said he was confident that European authorities will intervene quickly to stem any fallout and “evaluate any implications for the conduct of monetary policy and for financial stability”.
It has not just been politicians and officials who have been pressing the point that the risk of contagion across the banking sector is low — analysts at Deutsche Bank and Citigroup said the SVB crisis had little bearing on the outlook for lenders in Europe, which have recently posted robust profits.
Nonetheless, some European traders viewed banking stocks through the lens of the collapse at SVB, which came through in the insurance of Credit Suisse's bonds.
The cost of insuring the bonds of Credit Suisse against default climbed to the highest on record on Monday and the bank's shares lost another 15 per cent.
The insurance — known as credit default swaps (CDS) — on its bonds increased by 19 points.
However, Credit Suisse shares were among the day's worst performers not just because of SVB contagion concerns, but also due to persistent worries over the bank's restructuring plan and the fact that it has delayed its annual report following a last-minute query from US regulators over previous financial statements.
Not that Credit Suisse was alone in Europe — the CDS of Italian bank UniCredit jumped by more than 8 points, while the CDS of German banks Deutsche Bank and Commerzbank and Spanish banks Banco Santander and Banco Bilbao Vizcaya Argentaria also rose.
But while it could be argued the problems of Credit Suisse were a separate issue, the SVB fallout was knocking on the door of another US bank, First Republic, on Monday.
Despite assurances from the bank that it has $70 billion in unused liquidity gleaned from agreements with the likes of the Federal Reserve and JPMorgan Chase, shares in First Republic were marked down by as much as 78 per cent on Monday.
It has only been a few weeks since many of Europe's banks were reporting bumper profits on the back of rising interest rates.
The problem is that higher net interest margins — the difference between the rates at which banks lend money and the rates they pay on deposits — can be an indicator of trouble ahead.
Yes, they increase profits for the banks, but they also indicate the cost of capital becoming more expensive for their customers and that, in turn, can lead to an increase in bad debts, as some customers are unable to cope with rising interest rates.
“As the combination of higher interest rates and inflation puts the squeeze on many borrowers those borrowers have struggled to pay interest and service their debt, with the result loans have gone sour”, said Russ Mould, investment director at AJ Bell.
“This has forced the banks to take higher bad loan charges on both sides of the Atlantic. Higher rates are not a win-win for banks.”
So, the big question then becomes, in their battle against inflation, have central banks raised interest rates too fast for businesses to adapt?
Perhaps, say many analysts, and it has led to a shift in the bond markets, which are now betting that, at most, the Federal Reserve will raise interest rates by 0.25 per cent, with some even speculating that leaving them on hold is the most likely outcome at the rate-setting meeting next week.
Compare that to a week ago when 70 per cent of market participants had priced in a rise in interest rates of 0.5 per cent.
“The Fed may now find itself between a rock and a hard place”, said AJ Bell's Mr Mould.
“It wants to tighten policy to keep a lid on inflation but will now face questions as to whether policy is already too tight, given this nasty wobble in the banking system and the pressure higher rates are already putting on many companies’ cash flows.”
If the Fed does pause to think about that nasty wobble and entertain the possibility that it may have been thrashing inflation so hard with the interest-rate stick that it forgot that there can be other consequences, that may not be a bad thing, say some analysts.
“From the Fed’s point of view, there are additional dangers that need to be reviewed, which will take some time”, Carol Pepper of Pepper International told Bloomberg Television.
“So I’m hoping that this will help them to have a good reason to pause because frankly creating financial stability is the number one job at the Fed.”
Meanwhile, the European Central Bank is due to meet on Thursday and while President Christine Lagarde signalled a half-point hike was highly likely at its last monetary policy meeting in February, traders are now pricing in a rise of half that figure.
Whether or not the whole SVB saga has brought an early end to the battle against inflation is probably too early to call. It may just be a pause in hostilities, as time is taken to reassess.
Using interest rates to control inflation is often compared to smashing a walnut with a sledgehammer. This may be one of those times when using that sledgehammer risks creating a Pyrrhic victory.