The collapse of three U.S. banks, including SVB, sparked fears of contagion. These concerns were compounded by the subsequent rescue of Credit Suisse in Europe, despite Switzerland’s Parliament rejecting the government’s proposed $120.82 billion aid for Credit Suisse’s merger with UBS.
Seeking regulatory insights, Economy Middle East reached out to BSA, a leading law firm headquartered in Dubai. Partner Michael Kortbawi and associate Maroun Abou Harb provided the following responses.
Causes behind the collapse of SVB and other U.S. banks
The collapse of SVB and other U.S. banks can be attributed to a range of regulatory failures and weaknesses. One key factor was the inadequate supervision and oversight of lending practices and risk management strategies by regulatory bodies, including the Federal Reserve, Office of the Comptroller of the Currency, and Federal Deposit Insurance Corporation.
Specifically, these regulatory bodies failed to identify and address risky lending practices, such as excessive lending to the technology industry and overly aggressive lending, which contributed to the collapse of banks like SVB. Moreover, the lack of effective measures to control systemic risks and prevent contagion between financial institutions worsened the impact of bank failures and caused wider economic instability.
In addition, some experts argue that the regulatory framework itself had deficiencies, including overly complex, fragmented, and reactive regulations that allowed banks to exploit loopholes and engage in risky behavior that ultimately led to their collapse.
Following the 2008 financial crisis, regulatory reforms were introduced to strengthen the oversight and resilience of the U.S. banking system, such as the Dodd-Frank Wall Street Reform and Consumer Protection Act. However, the effectiveness of these reforms remains a subject of debate, with some experts calling for further regulatory action to prevent future bank collapses.
Read: First Citizens Bank acquired $72 bn in assets from collapsed SVB
The impact of the collapse on businesses and financial institutions in the Middle East
The collapse of Silicon Valley Bank has created uncertainty and concern for businesses and financial institutions in the Middle East, particularly for startups and other companies that relied on SVB for funding. This challenging environment has made it difficult for these businesses to secure alternative sources of funding and support, impeding their growth and expansion plans.
The repercussions of the SVB collapse could also extend to the wider startup ecosystem in the Middle East, potentially shaking investor confidence and hindering future investment, which may slow down growth and innovation and impede new startups from entering the market.
Despite these challenges, venture capital firms remain crucial in funding early-stage startups, and many will continue to do so despite the SVB collapse. However, it may take time for the startup ecosystem to recover, but the resilience and determination of the community should not be underestimated.
Regarding high interest rates and their effect on bond yields, it should be noted that when interest rates increase, new bonds with higher yields become available, which can make existing bonds with lower yields less attractive to investors. This can lead to a decrease in demand for existing bonds, causing their prices to fall and their yields to rise, which could negatively impact bond yields.
When an investor purchases a bond, they are essentially lending money to the bond issuer, which can be a corporation or a government entity, for a fixed duration. In exchange, the investor receives periodic interest payments (known as “coupon payments”) and their principal investment back upon the bond’s maturity. A bond’s yield is the total return an investor can expect, considering its price and coupon payments.
The relationship between interest rates and bond yields is inverse; that is, when interest rates increase, bond yields decrease, and vice versa. This occurs because new bonds issued when interest rates are higher usually offer higher yields, which makes existing bonds less appealing. Conversely, when interest rates decrease, newly issued bonds have lower yields, causing existing bonds to become more attractive.
To illustrate, let’s say an investor purchases a $1,000 bond with a 5 percent coupon rate and a maturity of 10 years. The yield on this bond is 5 percent since the investor receives $50 in annual coupon payments, which is 5 percent of the bond’s $1,000 face value. If interest rates increase, new bonds with a 7 percent coupon rate may be issued, making the existing 5 percent bond less appealing to investors, causing its price to fall. As the price falls, the bond’s yield increases, making it more attractive to investors until it’s on par with the new 7 percent bonds.
Contingency measures for banks to avoid exposure to excessive withdrawals
Banks worldwide have contingency plans to manage liquidity risk and prevent potential depositor panic. These plans may include maintaining appropriate levels of liquid assets, establishing credit lines with other banks or central banks, and implementing communication strategies to reassure depositors during times of uncertainty.
However, the possibility of depositor panic is not limited to any specific region or country, including the UAE, Saudi Arabia, or the broader Middle East region. Any bank could face a run on deposits if depositors become concerned about the bank’s financial stability, which could be triggered by factors such as an economic crisis, sudden economic changes, or rumors of insolvency.
To prevent depositor panic and minimize its effects, banks must maintain transparent and proactive communication with their clients, keep adequate levels of capital and liquidity, and implement risk management strategies that address potential liquidity shocks. Regulators also have a critical role in ensuring that banks have suitable contingency plans in place and comply with regulatory requirements.
In today’s digital era, mobile banking has become increasingly popular and can contribute to any bank’s collapse if customers start withdrawing their deposits in large numbers. Mobile banking allows customers to transfer money between banks without restrictions, leading to a chain reaction that could result in a bank’s insolvency. To mitigate this risk, banks must maintain sufficient levels of capital and liquidity and implement effective risk management practices.
Legal recourse for GCC business owners in case of bank failures
Business owners in the GCC may have legal options to recover losses in the event of a bank failure caused by fear contagion. One option is to file a claim with the Deposit Protection Scheme, a regulatory framework that provides compensation to eligible depositors up to a certain limit, varying depending on the regulations of each GCC country. However, businesses with deposits exceeding the limit may not be fully compensated.
Alternatively, legal action can be pursued against the bank or its directors and officers for any negligence or wrongdoing. A lawyer can assist in exploring legal options and feasibility. It is worth noting that legal recourse may vary based on the circumstances of the bank’s failure and the laws of each GCC country.
However, in the case of SVB’s collapse and its effects in the Middle East, it is unlikely that Middle Eastern startups would have grounds to sue SVB, as they typically do not have a direct relationship with the bank. SVB primarily acts as a financial intermediary between VC firms and their portfolio companies, and therefore startups are not considered depositors and would not have legal recourse against the bank.
Regulatory measures needed by governments and central banks in the region
In the wake of recent events, governments and central banks in the region are implementing regulatory measures to bolster the resilience of the financial system and mitigate the likelihood of similar occurrences. This involves the implementation of new regulations and policies designed to improve the stability, transparency, and accountability of financial institutions.
For example, the Central Bank in the UAE has introduced various regulatory initiatives in recent years to enhance the banking sector’s resilience. These include the adoption of the Basel III regulatory framework, which reinforces banks’ capital and liquidity requirements, and the establishment of a resolution framework that facilitates the orderly resolution of banks in the event of their insolvency.
The Basel III regulatory framework is a set of international banking regulations formulated by the Basel Committee on Banking Supervision as a response to the 2008 financial crisis. Its objective is to fortify the resilience of banks and the stability of the financial system by enhancing risk management, increasing the quality and quantity of capital held by banks, and improving banks’ liquidity.
Basel III has implemented stricter capital requirements for banks, including a higher minimum capital requirement for systemically important banks and a new capital conservation buffer. The quality of capital requirements has also been revised, placing greater emphasis on Tier 1 capital, which consists of equity and retained earnings.
Moreover, Basel III has introduced a new liquidity coverage ratio, which mandates banks to hold sufficient high-quality liquid assets to cover their expected cash outflows over a 30-day period of stress. This measure is aimed at ensuring banks have sufficient liquidity to meet their obligations during financial turmoil.
Similarly, the Saudi Arabian Monetary Authority has taken several measures to bolster the financial system’s resilience, including enhancing supervisory frameworks and regulatory requirements, as well as implementing a deposit insurance scheme to safeguard depositors in the event of bank failure.
The Saudi Arabian Monetary Authority is the central bank of Saudi Arabia and holds several responsibilities, including implementing monetary policy, regulating the financial sector, and maintaining the stability of the national currency, the Saudi riyal. SAMA oversees and regulates the banking and insurance sectors, manages foreign exchange reserves, and promotes financial inclusion and infrastructure development.
As a regulator, SAMA enforces regulatory standards, such as capital and liquidity requirements, corporate governance standards, and anti-money laundering and counter-terrorist financing regulations, for banks and other financial institutions operating in Saudi Arabia. It also supervises the implementation of payment and settlement systems in the country and has established a deposit insurance scheme to safeguard depositors in case of bank failure, ensuring a safety net for consumers and businesses.
Governments and central banks in the region are proactively strengthening the regulatory framework to ensure the stability of the financial system. However, regulators need to remain vigilant and adapt their frameworks to address emerging risks and maintain financial stability as financial systems and market conditions continue to evolve.
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