So much has been said about why Silicon Valley Bank (SVB) and Credit Suisse (CS) failed. Some blame the banks’ failure to manage risk properly. Others say central banks’ aggressive interest rate hiking regimes was a main reason. While interest rates and risk management both played an important role, what triggered SVB and CS’s downfall was a classic bank run, a panic-induced rush among depositors to withdraw their money.
This “madness of crowds” phenomenon is more often than not driven by irrational behaviour of market participants than financial reality.
Irrational behaviour is part of human psychology. In a world where markets are subject to irrational reaction, banking executives need to choose words and actions carefully to ensure correct inferences are reached by market participants.
In fact, in the case of SVB, the bank might not have collapsed had it not spooked depositors by revealing its struggles the way it did.
SVB crisis triggered by bond sales announcement
The panic started on 8th March when SVB announced that it had sold $21 billion worth of bonds at a $1.8 billion loss and planned to cover the shortfall by selling shares.
After the announcement, prominent venture capitalists such as Peter Thiel of Founders Fund started raising alarms on social media, urging startups to pull their deposits out of the bank to avoid losing money in the event of a bank run.
Panic then spread like wildfire across Twitter and private Slack channels, and clients pulled more than $42 billion in a single day in what House Financial Services Committee Chairman Patrick McHenry called “the first Twitter fuelled bank run.” With share prices plummeting, SVB was unwilling to find an investor and couldn’t cover its withdrawals.
In one aspect, the SVB crisis shone a spotlight on the importance of market signalling and communications on the bank’s part.
Behavioural economist Hersh Shefrin pointed out in a brilliant op-ed on Forbes that ‘the bank was solvent when it collapsed.’ Its assets, more than $210 billion, held more than enough value to cover the bank’s deposits, about $175 billion. And neither the $1.8 billion loss from the bond sales nor its plan to sell new bank shares posed an imminent threat to uninsured deposits.
Based on rational analysis of the bank’s financial health at that point, the risk was overblown. That fact was completely overlooked by market participants and commentators, both was overwhelmed by the emotion of the moment.
This crisis serves as a reminder that, in the irrational world we are in, it is crucial to manage the signals banks send to markets. In the case of SVB, if large losses were anticipated to spook nervous depositors and investors, then it should try to spread transactions over time to make them less prominent. The bank should also try to be proactive in public messaging and communications, putting the emphasis on solvency and the safety of deposits.
This was what SVB tried to do, but only after the bond sales announcement, when panic had already spread. The bank contacted major depositors, telling them that their deposits were safe. But such reassurances came too late. In a situation where trust was already diminishing, they were in fact more likely to have backfire effects.
Credit Suisse and the costly ‘absolutely not’ comment
CS’s demise, unlike SVB’s, was a long time coming, with a culmination of years of scandals and multibillion-dollar losses. However, the sharp downturn that led to the bank’s emergency sale was also partially the fault of an off-the-cuff comment by the then Chairman of Saudi National Bank (SNB), CS’s largest shareholder.
Chairman Ammar AlKhudairy was asked in an interview with Bloomberg if SNB would increase its stake in the troubled Swiss lender. His reply was “absolutely not.”
The comment triggered investor panic and sent CS shares into freefall. Clients rushed in to withdraw $35 billion in three days. The bank’s fate was sealed several days later with a forced takeover by its arch-rival UBS at a knockdown price.
To be fair to AlKhudairy, he was only saying that the Saudi bank could not increase its stake above 10% for practical and regulatory reasons, and that he didn’t think CS needed extra capital because its financial ratios are “fine”. There was nothing new in his comments either, SNB already said in October that it had no plans to expand its holdings beyond the current 9.9%.
He just happened to say this in an awkwardly blunt way, and at a particularly terrible moment when there were rampant fears around CS and the banking sector in general in the aftermath of SVB’s collapse.
Following his comments, AlKhudairy tried to minimise what he described as “panic”. “If you look at how the entire banking sector has dropped, unfortunately, a lot of people were just looking for excuses,” he told CNBC. “It’s panic, a little bit of panic. I believe completely unwarranted, whether it be for Credit Suisse or for the entire market.”
Again, the damage was already done, and nothing he could say at that point could salvage the situation.
As the largest shareholders, SNB had the most to lose when CS went under. It is then not a big surprise that SNB announced earlier this week that its Chairman Alkhudairy had resigned for “personal reasons.”
SNB is now sitting on losses of $1.2bn from its investments in CS. Alkhudairy’s comments on how the Saudi bank would “absolutely not” increase its stake in CS has proved to be two very costly words.