Following recent banking failures – including Silicon Valley Bank (SVB) in March, and more recently JPMorgan Chase’s rescue of First Republic Bank – serious questions have been asked about the stability of the global financial system. In many of the cases, rising inflation had put added pressure on banks’ balance sheets, with large amounts of customer withdrawals proving to be the final nail in the coffin.
It’s a difficult time for businesses – not just for those with deposits or loans with under-pressure or embattled banks. So what does the banking landscape look like in the wake of these failures, and what is the outlook for banking M&A activity.
We asked Peter Davis, EY Americas Financial Services Markets & Solutions Leader; John Walsh, EY Americas Banking and Capital Markets Leader; plus Sid Khosla, EY Americas Financial Services Strategy and Transactions Managing Partner for their perspective.
Where things have gone wrong, regulators and other banks have stepped in fairly quickly to protect customers. Is everything back to normal now, or do you still see ongoing problems as a result of recent banking failures?
Peter Davis (PD): We continue to see elevated risk in the market. While the focus has been on deposits and balance sheet management, we are now seeing a shift in focus to potential credit losses.
What are the broader implications of the SVB, Signature and First Republic collapses on the banking market?
PD: The rapid bank failures will redefine playbooks for crisis management, with respond-readiness times reducing from days to hours.
The rapid bank failures will likely accelerate the trend in banking consolidation, as customers balance personalised services with security in times of significant market stress.
For large regional banks, we can expect the adoption of the capital, liquidity and resiliency requirements previously reserved for the largest banks.
Do you think we’re over the worst of it, or should we still be bracing ourselves for more volatility?
PD: We don’t yet fully understand the knock-on impacts of the rapid rise in interest rates. Significant unrealised security losses combined with potentially rising credit losses and continued deposit outflows could place much greater pressure on local and regional banks.
In an environment rich in real-time information, emerging stresses can quickly escalate to a market crisis. Firms are staying vigilant as to their potential stress points and changes in market sentiment.
Do you think the past few weeks show inherent flaws or weaknesses in the banking system, particularly in terms of how banks hedge their bets?
John Walsh: Despite this market volatility, we are in a much better place than where the US banking sector was in 2007. This is in large part due to the significant investments the industry has made in enhancing risk management, expanding capital and liquidity buffers, and undertaking ongoing stress testing and contingency planning. We expect that many firms will take this opportunity to review what further enhancements, if any, might be appropriate in light of the risks that have emerged in recent weeks. We should also recognise that periods of increased volatility often give rise to growth and diversification opportunities which could be tied to:
- Product innovation targeting new markets/customers or addressing the underlying volatility;
- Changes made to business portfolios through carefully considered organic or inorganic options; or
- Enhanced customer interaction driven from new technologies and partnerships
It will be critical for management to strike an appropriate balance between the pursuit of these growth opportunities and resiliency of their financial institution regardless of what they plan for the future. As banks mobilise against the resulting market opportunities, they need to make sure they understand how to properly manage the new aggregate risk profile of the institution.
What impact will this volatility have on investment and the M&A landscape?
Sid Khosla (SK): Underlying drivers of banking M&A remain the same – scale, efficiency, and the need to constantly invest in technology to stay competitive. I think we need more time to see how the recent turmoil shakes out. We’re not yet seeing bank CEOs talk about M&A in public, but that’s not surprising given they are focused internally at the moment. There are certainly opportunities for banks who are willing to go on the offensive or be bold and steal a march on their competitors. On the investment side, that remains a strategic imperative and there are opportunities for banks to take advantage of the current valuation swoon of fintechs.
We also see partnering as the ‘new M&A’. Using partnerships to help meet evolving customer expectations has become a preferred way to move quickly into new strategic areas, such as digital assets, or to access revenue-generating capabilities quickly and with less capital than building or buying.
Banks aren’t going to get past this period without scrutiny, are they? Do you expect stricter regulation is inevitable now, and if so what could this mean for banks?
SK: I think there are two angles to this – bank M&A regulation and banking sector oversight. Bank M&A has already come under increased scrutiny with larger deals taking longer to close. It’s very early to know if this might change. Regulators could take a pragmatic view to deals in the shorter term to enable them to close (if it is done to protect a bank, or protect customer deposits). In the medium-term, we could see deals gain approval if they are seen as a way of strengthening the sector.
On the topic of banking sector oversight, there is a lot of speculation in this area and the Federal Reserve plans to review stress-testing requirements for smaller banks. One possibility is that we’ll see deeper scrutiny of larger banks (US$250bn+) and an overall expansion of the supervisory threshold to include smaller banks (over US$50bn, but US$100bn has also been mentioned in the media). This also has the effect of increasing costs for banks, again providing another driver for future M&A.
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