'We’re still in the middle of this': Rotman Dean Susan Christoffersen unpacks global banking woes

The banking crisis that has toppled several financial institutions in recent weeks remains ongoing – and while the Canadian financial sector is well protected against the contagion, experts say it is not entirely immune.

When Silvergate Capital, a lender that focused heavily on the crypto industry, announced it was shutting down operations on March 8, it was broadly received as a standalone incident that was the result of the lender being overly dependent on the now-bankrupt crypto exchange FTX.

But the sudden collapse of California-based Silicon Valley Bank (SVB) a couple of days later wasn’t so easy to dismiss. It marked the largest banking failure since the global financial crisis of 2008. A few days after that, Signature Bank suffered the same fate, becoming the third-largest bank failure in American history. Then came Credit Suisse, which was on the cusp of collapse when it was bought out by Swiss banking rival UBS on March 19.

While the underlying circumstances can be varied and complex, a bank failure generally occurs when a financial institution is unable to fulfill its obligations to creditors and depositors – either due to insolvency or a liquidity crunch. And, worryingly, a bank failure can spread particularly quickly in a digital era stoked by social media.

“We’re still in the middle of this,” says Susan Christoffersen, dean of the University of Toronto’s Rotman School of Management. “There’s a contagion problem that can happen when you have a banking crisis and that’s the reason why you absolutely need regulators to do what they’re doing now.”

When a bank faces unexpected liquidity pressures from depositors, it typically is forced to sell off its assets at heavily discounted prices, which can devalue similar assets held by rival banks. Christoffersen says this, in turn, can adversely affect the capital buffers and the confidence of depositors at otherwise healthy banks, placing them at risk. 

“This is why it’s so important for regulators to step in and not let banks like SVB sell off its assets at massive losses,” says Christoffersen, whose research includes a focus on the role of financial institutions in capital markets.

In the wake of the SVB failure, American regulators quickly rolled out emergency measures that put the bank under the control of the Federal Deposit Insurance Corporation (FDIC). The FDIC guaranteed depositors would have access to all their funds even though the organization only insures individual deposits up to US$250,000. North of the border, the Canada Deposit Insurance Corporation (CDIC) similarly insures deposits held at Canadian banks up to $100,000.

“It seems that the interventions are certainly helping, but it creates nervousness,” Christoffersen says. “If I had an uninsured deposit, I might be anxious about whether or not this crisis might affect my bank since it is difficult to know in real time the quality of assets being held and the potential impacts of economic shocks. The speed at which money can move also adds a whole other level of uncertainty.”

Though regulators have taken steps to reduce their frequency and impact, bank failures remain a risk – particularly during periods of high inflation and rising interest rates.

Christoffersen explains that banks generally use deposits in ways that boost the economy, such as handing out loans to new businesses or homebuyers. But that leaves banks vulnerable to a sudden panic because the money is invested over the long term, making it difficult to meet short-term liquidity demands should all customers want to pull their money out at the same time.  

In the case of SVB, the bank succumbed to pressure from both the liability side and the asset side. On the liability side, SVB was heavily dependent on depositors from a single industry – tech – and recessionary pressures coupled with a scarcity of alternative funding sources meant SVB’s customers were more reliant than most on the funds they had sitting in the bank.

“It also had an abnormally high rate of depositors who were not covered by the FDIC guarantee,” added Christoffersen. “[Clients] were much more wary of their bank’s financial difficulties and were much faster to pull their cash out since it wasn’t insured.”

SVP also invested a lot of its assets in low-interest, longer-term bonds.So, as interest rates went up, the value of the bonds plummeted and eroded capital buffers.

While the circumstances surrounding SVB’s collapse may be unique, it nevertheless highlighted the degree to which the sector relies on consumer confidence. Which means the high-profile banking failures dominating the news in recent weeks potentially puts every bank at risk.

Christoffersen, however, says that Canadian institutions are much less exposed.

“Our banks fared very well during the [2008] financial crisis, and I think part of it is the different regulatory environment that we’re in,” she says.

For example, while the United States has a patchwork of state and federal regulators overseeing its financial sector, Canada’s Office of the Superintendent of Financial Institutions (OSFI) oversees all banks in Canada regardless of size or ownership structure. Furthermore, while there are more than 4,200 banks south of the border, there are just 81 banks operating on Canadian soil – 34 of which are owned and operated domestically.

“Our banks are fewer, larger, and tend to have more diversified types of deposits. In addition, our regulations are more standardized; we have pretty robust capital requirements,” says Christoffersen. “That means the asset values can fluctuate pretty significantly without resulting in insolvency and affecting depositors.”

Canada’s largest banking failure occurred at the Home Bank of Canada in 1923. Since then, only two small regional banks – the Canadian Commercial Bank and Northland Bank – have gone under, both in September of 1985. (Both institutions were founded during the oil and gas boom of the mid-1970s and invested heavily in energy-related real estate, only to have their loan portfolios deteriorate in the early 1980s due to rising interest rates and downward pressure on the Canadian dollar.)  

“Canada has a pretty robust and healthy system – that’s the benefit of having larger and more diversified banks that can better manage risks,” says Christoffersen. “That doesn’t mean bank runs can’t happen here, but I’m not pulling my money out just yet.”

This story originally appeared at the Rotman Insights Hub.