Weekly Business Insights from Top Ten Business Magazines | Week 292 | Shaping Section | 2

Extractive summaries of and key takeaways from the articles curated from TOP TEN BUSINESS MAGAZINES to promote informed business decision-making | Week 292 | April 14-20, 2023

Banking Crises Are Preventable, But Human Nature Gets in the Way

By Max Abelson | Bloomberg Businessweek | 15 April 2023 

Listen to the Extractive Summary of the Article

The history of banking is, at least in part, a kind of horror story that keeps repeating itself.  Back during the Venetian Renaissance in the 14th and 15th centuries, the business was so fragile that a rumor of someone withdrawing cash was enough to send depositors into a panic. For Amsterdam bankers in 1763, it was a grain deal with Russians at the end of wartime that helped stir up crisis. Almost a century ago, during the Great Depression, about 9,000 banks failed in the US alone.  This year, angst about losses on bond investments and large uninsured deposits helped trigger two of the biggest US bank failures ever. The problems are old, and the system is delicate: We let banks make long-term investments, including loans and bonds, while taking deposits from customers who can demand them back whenever they want.

Deposit insurance, central bank backstops and regulation make panics less likely. Even so, banking and financial crises are.  After a crisis, regulations inevitably become tighter, but then as memories fade, regulations often relax. And whatever rules regulators design, over time financiers will eventually find creative ways around them.  

Besides guaranteeing deposits, regulators can watch how bankers manage their books and invest their assets. Canada manages to have “wonderfully boring” banks.  The recipe for stability is to have well-capitalized, risk-averse banks.   A well-capitalized bank is something like a homeowner with a lot of equity: It has a financial cushion to absorb losses on the value of its assets. But banks won’t naturally gravitate toward such behavior. They need thorough and steady regulation that doesn’t ease up when the economy is humming.  

That can be easier said than done. Bankers are adept at finding new ways to squeeze out profits that can eventually get them into trouble. For example, in the early 2000s, Wall Street’s financial engineers figured out how to make risky mortgages look like safe investments.  Often, regulators do not know of such loopholes in real time; therefore unknown risks are mounting in the shadows, until a crisis hits the system.

3 key takeaways from the article

1. The history of banking is, at least in part, a kind of horror story that keeps repeating itself.  This year, angst about losses on bond investments and large uninsured deposits helped trigger two of the biggest US bank failures ever. 
2. The problems are old, and the system is delicate: We let banks make long-term investments, including loans and bonds, while taking deposits from customers who can demand them back whenever they want.
3. Deposit insurance, central bank backstops and regulation make panics less likely. Even so, banking and financial crises are.  After a crisis, regulations inevitably become tighter, but then as memories fade, regulations often relax. And whatever rules regulators design, over time financiers will eventually find creative ways around them. 

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Topics:  Banking, Financial Crisis, Regulations