The complex issue of systemic risk in banks is raising alarms for those in charge of regulations and policies. This refers to the possibility of one struggling bank causing a domino effect, triggering financial crises that could have widespread effects on the real economy.
Identifying Weak Spots:
Visualizing the banking system as a chain of links, where a single weak link can lead to trouble for the entire financial system. Think of it like a chain reaction of falling dominos, where problems in one bank can quickly spread to others, potentially causing a major financial crisis. This can then impact the broader economy, making borrowing difficult, causing the value of assets to drop suddenly, and creating uncertainties in the economy.
Predicting the Future:
To understand where systemic risk is headed, we need to consider various factors that guide us along different paths. These factors include the decisions made by the central banks, trends in inflation, and the overall economic ups and downs.
(see; Z. O. Kurter (2024), https://doi.org/10.1016/j.najef.2024.102083).
These factors together create the complex story of systemic risk.
Feeling the Impact:
Systemic risk is closely connected to the overall macroeconomic conditions. For instance, previous study shows that how macroeconomic conditions affect the systemic risk in the short and long run.
(see; Z. O. Kurter (2024) https://doi.org/10.1016/j.najef.2024.102083)
Patterns of Systemic Risk: Learning from History
Looking back at history, we see that peaks in systemic risk in banks often align with major distress economic events. (see; Z. O. Kurter (2024) https://doi.org/10.1016/j.najef.2024.102083))
Recent events, such as the Silicon Valley Bank’s failure could reshape our understanding of systemic risk.
Central Banks’ Readiness:
Learning from the global financial crisis of 2008, European and US banks have taken steps to strengthen themselves by increasing financial reserves, improving capital holdings, and implementing stricter macroprudential regulations. However, the effectiveness of these measures might be tested again as banks face new challenges linked to the process of unwinding quantitative easing (QT). This involves reducing available deposit funds, which could become a challenge, especially if interest rates continue to rise rapidly. This scenario could heighten the risk of a significant systemic crisis over the long term in those banks due to potential liquidity shortages.
New Banking Challenges: Shadow Banking
At the same time, the shadow banking sector is growing rapidly. Operating with fewer regulations than traditional banks, these entities are taking on riskier ventures for potentially higher returns. Their main role is to lend funds to banks globally. If some major central banks continued to raise interest rates rapidly (as they did until September 2023), shadow banks might have followed suit, posing challenges for certain banks in accessing funds during crises.
Monitoring Regulations and Challenges:
Regulators and policymakers are keeping a close eye on these trends, considering how higher interest rates might impact European and US banks’ ability to stay liquid and profitable. Their main goal is to maintain financial stability, even as significant changes occur.
The IMF’s article (see: https://www.imf.org/en/Blogs/Articles/2023/08/08/tracking-global-financial-stability-risks-from-higher-interest-rates) underscores that while interest rate hikes typically favour lenders, enabling them to earn more on loans than they expend on borrowing, the current scenario deviates from this conventional pattern.
The Influence of Real Estate:
Commercial real estate is also a factor in risk. If interest rates continued to rise aggressively (cost of borrowing goes up), this would have made it difficult for these properties to get loans, it could have led to problems for some banks and made the riskier. If the economy doesn’t grow as expected, this can cause more problems. It’s like a chain reaction.
Dealing with Big Economic Changes:
Things like conflicts, like the Russia-Ukraine war, can make banks riskier due to higher inflation. High inflation means higher loan costs for banks, making them riskier. These changes can lead to more instability in the long run.
Conclusion: Navigating the Complexity of Systemic Risk:
Systemic risk in banks remains a critical concern, influenced by macroeconomic conditions, central bank policy, and global distress events.
(see; Z. O. Kurter (2024) https://doi.org/10.1016/j.najef.2024.102083).
To handle these risks well, we need to really understand how all these things fit together.
References:
Zeynep O. Kurter ‘How macroeconomic conditions affect systemic risk in the short and long-run’?
The North American Journal of Economics and Finance, Volume 70, January 2024, 102083
Zeynep Özde Kurter 