At the latest with the collapse of the Swiss bank Credit Suisse, concerns about the emergence of a banking crisis, which could also hit Germany hard, escalated – just look at the nervousness surrounding Deutsche Bank. Politicians and banks in this country are reassuring that this is not foreseeable here. While this reaction is understandable, the risks are significant. Politicians must now act wisely in order to create trust through transparency and honesty on the one hand and to prevent an escalation on the other.
The first domino was the Silicon Valley Bank in California. The rescue of the major Swiss bank Credit Suisse was even more dramatic. The big question now is whether these bank failures are the first dominoes in a chain. And whether this could lead to a systemic banking crisis worldwide, which – similar to the global financial crisis of 2008/09 – will end in a deep recession and a rise in unemployment.
Huge misjudgment
As is so often the case, there are good reasons for optimism. But: Financial and banking crises are, by definition, almost unpredictable. And they are often accompanied by fundamental errors. At the beginning of September 2008, it was said that the global financial system could cope with the bankruptcy of the investment bank Lehman Brothers. A gigantic misjudgment.
Even today, an analytical look at the financial system and politics reveals three short-term and three long-term problems. In the short term, mistakes were made on all sides, in banking supervision as well as in the ECB and the federal government. One of the biggest was the assumption that financial institutions could weather high inflation and sharp interest rate hikes unscathed. It was already foreseeable in spring 2022 that the central banks would have to raise interest rates massively in a very short time with inflation rates approaching ten percent and that this would lead to enormous losses in assets and above all fixed-interest bonds. It is difficult to understand why the financial and banking supervisory authorities did not recognize this immediately during their stress tests and initiated countermeasures.
In addition, when the ECB raised interest rates recently, it argued that fighting inflation was a higher priority than safeguarding financial stability. This is at best a risky decision, at worst a mistake she will soon have to correct. Of course, it is understandable that you want to separate price and financial stability and protect them in different ways. However, one has a major impact on the other, so monetary policy cannot ignore them.
Also read: 5 reasons why the Deutsche Bank crash wasn’t as irrational as many think
What remains is political communication. No one – not even a federal finance minister – should publicly promise that their own financial system is secure and that problems similar to those in the USA or Switzerland cannot also arise in this country. The fact is that no one knows, even the best-informed banking supervisors cannot say for sure. However, the mistakes that have contributed to the current crisis are not limited to the past 12 months. They go back to the insufficient lessons learned from the 2008 global financial crisis. Despite many correct reforms, failures can still be stated in three central points.
First: The “too big to fail” problem has still not been solved 15 years after the financial crisis. There are still banks that are so big that the state has to bail them out. Credit Suisse has made so many mistakes and caused so many scandals in recent years that any other non-bank company would have been broken up long ago. In the US, the ailing Silicon Valley Bank was closed, but investors were completely rescued with their deposits. A wrong signal.
Secondly: The perverse incentives for the management of private banks have not been fundamentally eliminated to this day. When things are going well, salaries and bonuses are gigantic. Worst case scenario, if things go wrong, you’ll lose your job and change employers to continue the game. The financial incentives are ultimately geared towards taking high risks. Financial crises are not made by a higher power, but by people. They are the logical result of this system failure in which profits are privatized and large costs are socialized. Without stricter regulation, there will regularly be expensive bank failures at the expense of taxpayers.
Third: The inadequate reforms of the financial institutions themselves. In Europe in particular, important opportunities were missed after the global financial crisis. Too many banks in Europe and also in Germany are inefficient and therefore comparatively risky. For example, banks in Germany are characterized by relatively high costs, which not only make them less profitable, but also make them too inflexible in difficult times. The difficult task for politics and state institutions is now to prevent the outbreak of a systemic banking crisis. Even today there are many good reasons why a systemic crisis can and will be prevented. However, this is not a sure-fire success. It’s to be hoped that Murphy’s Law doesn’t apply again: if something can go wrong, it will go wrong.
Also read: The risk of a banking crisis is increasing
