Banking Crisis: Economists Do Not Expect a Severe Financial Crisis and Continue to Call For Interest Rate Hikes to Combat Inflation
Banks in Europe and America are currently gripped by a great deal of uncertainty. The 42nd ifo and FAZ Economists Panel focuses on the current turmoil in the financial system. The survey, in which 132 economics professors participated, was conducted from March 23 to March 30, 2023.
In March 2023, the largest banking collapse since the 2007/ 2008 financial crisis occurred, and one of the causes was the central banks’ change in course. After years of loose monetary policy, they had to continuously and sharply increase key interest rates due to high inflation. This put pressure on banks that hold a high proportion of low-interest government bonds in their portfolios. California’s Silicon Valley Bank (SVB) lost the trust of its customers within a very short time and was placed under the U.S. deposit insurance FDIC on March 10. In the meantime, the bank was taken over by a competitor. As a result, the markets also turned away from the Swiss bank Credit Suisse, which was taken over by UBS on March 19 with the assurance of government guarantees. And a week later, the share prices of two major German financial institutions, Deutsche Bank and Commerzbank, plummeted, even necessitating public support from German Chancellor Olaf Scholz.
Question of Liquidity of Systemically Important Banks Divides Profession into Two Equally Large Camps
Economists are split on the question of whether more systemically important banks will run into serious liquidity difficulties. About 38 percent of respondents do not expect any serious threat to the liquidity of systemically important banks. They rate Credit Suisse as a special case, as it had been troubled for some time. However, they generally assess the other systemically important banks as well capitalized. They believe that the measures taken so far are already having an effect and have started to calm the markets. They are also convinced that both governments and central banks have sufficient instruments and willingness to prevent a major crisis through their actions. In contrast, 36 percent of participants expect other systemically important banks to run into serious liquidity difficulties after Credit Suisse. They argue that other banks would face similar problems; in particular, they point to the unexpectedly rapid and sharp interest rate hikes, which are putting a heavy strain on assets at many banks. Further interest rate increases could deepen these problems.
Economists Disagree on Banking Sector Resilience
European Central Bank President Christine Lagarde publicly stated on March 20 that the euro area banking sector is resilient and has a strong capital and liquidity position. For this statement, 9 percent of participants said they agreed and another 37 percent said they somewhat agreed. At the same time, 22 percent take a neutral stance, 21 percent somewhat disagree and 8 percent disagree with the statement completely. This means that around half the participants assess the banking sector in the euro area as resilient and the other half express slight to considerable doubts about this.
No Danger of a Severe Financial Crisis like in 2007 and 2008
While economists are divided on the questions of how stable the financial system is and whether the turbulence has been overcome, they are relatively united in their conviction that a severe financial crisis on a scale similar to the 2007/2008 crisis is not on the horizon. Almost three quarters of the participating economists share this assessment. They state that both the initial situation of the current turmoil and the reaction to it are different compared to 2007. For example, they point out that there is less danger from price declines in government bonds than from bad and securitized mortgage loans. They also see progress in bank supervision and capitalization and feel that central banks as well as governments are better prepared for banking crises. Nevertheless, 18 percent of the participants see a threat of a severe banking crisis. They point to equity ratios that are too low and the fundamental unpredictability of crises.
Differing Assessments of the Success of Measures after the Last Financial Crisis
After the last financial crisis, governments and regulators took precautions to make banks sounder and protect taxpayers from liability. Looking at the handling of the struggling banks SVB and Credit Suisse in recent weeks, 48 percent of participants say the precautions were not successful. They consider it a mistake that no capital backing for government bonds was introduced and that equity ratios were generally set too low. They also criticize the fact that regulations have been relaxed in recent years. They see the specific handling of the two cases as a sign that governments will once again step in and taxpayers will be liable if banks falter. However, at 42 percent, a similarly high proportion of economics professors say they take a positive view of the provisions for sounder banks and taxpayer protection. Tighter regulations, they say, have put only a few banks under pressure and kept the overall system stable. They also state that in a market economy, it is always possible for individual companies or banks to fail. SVB, they say, was a medium-sized bank with lax regulation, and Credit Suisse was poorly managed.
Majority of Economists Support Further Interest Rate Hikes
After a long period of expansionary monetary policy characterized by low (and in some cases negative) interest rates, central banks initiated the interest rate turnaround last year in response to galloping inflation. As a result of continuous interest rate hikes by central banks, fixed-interest bond values have declined. The current turmoil in the financial system was triggered by banks having to sell these bonds at drastic discounts before they matured and subsequently threatened collapse. Nevertheless, 67 percent of panel participants say that interest rates should be raised further to fight inflation. Looking at current developments in the financial system, 21 percent say interest rates should be held constant. Only 3 percent are in favor of lowering interest rates again.
Support for Raising Equity Ratios and Extending Them to Government Bonds
A full 72 percent of the participating professors say that, once the current turmoil is over, the equity ratios for European banks should be increased. They argue that this would transfer further risk from the government or taxpayers to banks and would encourage the banks to act more risk-consciously. At the same time, they see this as a confidence-building measure that makes the system as a whole more resilient and thus also better protects individual banks from a bank run. They view high equity as a reliable and effective form of bank regulation that can prevent future financial crises. Only 16 percent of the participants are against higher equity ratios. They consider the ratios to be sufficiently high and believe increasing them would put the competitiveness of European banks at risk.
Furthermore, 76 percent of German economists support the call for mandatory capital backing of government bond portfolios in the future. They state that government bonds also have credit and interest rate risks and should be hedged accordingly. In addition, there would be a financing advantage for governments and corresponding market distortions due to the current special regulation for government bonds. Only 9 percent of participants reject the call for capital adequacy requirements for government bond portfolios.
Disagreement on the Impact on Real Economic Development in 2023
A total of 44 percent of economists do not expect the current developments in the financial system to have any impact on growth in the real economy in 2023. Some of them argue that they do not expect any further upheaval in the financial system and therefore consider the crisis to be over and manageable in scope. Another group argues that other developments, such as the Russian war against Ukraine and inflation, have a greater impact on the real economy. In addition, some participants welcome a slight tightening of credit due to high inflation. In contrast, 41 percent of the participating economics professors expect negative real economic consequences. These are attributed in particular to increased uncertainty and more restrictive lending.
Keine Bankenkrise: Ökonominnen und Ökonomen erwarten keine neue Finanzkrise und fordern Fortsetzung der Zinspolitik
ifo Institut, München, 2023
ifo Schnelldienst, 2023, 76, Nr. 04, 75-78
