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The global banking turmoil since Silicon Valley Bank’s
SIVB,
sudden collapse continues, despite an effort by governments to calm depositors and provide liquidity to troubled banks.
On both sides of the Atlantic, the strategy for containing risk appears to copy the one favored after the 2008 financial crisis: Remove the rotten apples from the bunch by merging them with the good apples — healthy banks.
For example, First Republic Bank
FRC,
may be looking for a buyer, and Switzerland’s UBS Group
UBS,
is buying troubled rival Credit Suisse Group
CS,
at an apparently large discount.
Similar rescues occurred during the financial crisis in 2009. Some weak banks failed, but others had their balance sheets rolled back into the financial system through acquisitions, accommodated by regulators. For example, JPMorgan Chase
JPM,
acquired Washington Mutual and Bear Stearns, while Bank of America
BAC,
acquired Merrill Lynch and Countrywide Financial, and Wells Fargo
WFC,
acquired Wachovia.
In this bank panic of 2023, financial regulators hope a version of the 2009 playbook will restore stability to the global banking system. But will it?
Even with stronger capital buffers, lower leverage ratios and stress-testing imposed after the 2008-09 financial crisis, research by former U.S. Treasury Secretary Lawrence Summers and co-author Natasha Sarin shows that bank volatility and risk premiums did not decrease following the upheaval.
Risky business
What if the current mergers weren’t shotgun weddings, and the financial market was left to figure things out on its own? This was tried during the banking crisis of the Great Depression. Federal antitrust laws pertaining to banks were non-existent then and systemic-risk rules on mergers had yet to be invented, so banks were more or less free to acquire other banks at will.
That’s just what they did. About 10% of all banks that existed in 1934 — some 1,500 entities — acquired another bank. Even with the removal of more than 9,000 “bad apple” banks from the system — one-third through mergers, the rest through failures — risk in the U.S. banking system actually rose. Our research shows that risk on bank balance-sheets in 1934 rose by 10% and systemic risk rose by 30%. Banks with the biggest risk increases? Those acquiring other institutions.
“ Risk does not miraculously evaporate through mergers and acquisitions — it simply gets redistributed. ”
Lingering risk can exacerbate the liquidity crises and even lead to runs on solvent institutions. Indeed, in a recent speech, Vice Chair for Supervision of the Federal Reserve Michael Barr expressed concern about the risks that mergers can pose to financial stability.
It may be the case that mergers provide a band-aid in the short run. Indeed, new owners of troubled banks may bring better management practices, but don’t be fooled. As history shows, risk does not miraculously evaporate through mergers and acquisitions — it simply gets redistributed. Managers still have to manage risk, and regulators still have to check if these now-larger banks are piling up even more.
The Dodd-Frank law told us that future crises would be governed by “Living Wills” and “Orderly Liquidations.” That reality has not transpired. Shotgun bank weddings are not the only option in the crisis playbook. But if arranged unions are becoming standard, then regulators need real-time assessments of how they affect the system’s risk. They can’t wait for researchers to tell them after the fact.
Kris James Mitchener is the Robert and Susan Finocchio Professor of Economics at the Leavey School of Business, Santa Clara (Calif.) University, research associate at the National Bureau of Economic Research (NBER) and research fellow at the Centre for Economic and Policy Research (CEPR) and CESifo.
Angela Vossmeyer is an associate professor of economics in the Robert Day School of Economics and Finance at Claremont McKenna College and a Faculty Research Fellow at the National Bureau of Economic Research (NBER).
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