Lessons And Reforms For A Fragile Financial System

The turmoil reignited concerns about the stability of the global financial system, underscoring critical issues surrounding deposit behavior and interest-rate risks.
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In March 2023, the U.S. experienced its biggest banking failure since the 2008 global financial crisis. Several banks — including a major lender in the tech industry and a bank of global financial significance — crashed, as depositors hastily withdrew their savings, putting a strain on the already weak financial institutions dealing with soaring interest rates. Hundreds of billions of dollars were pumped into the system by lenders of last resort — central banks — and the banking industry’s strongest players.

The turmoil reignited concerns about the stability of the global financial system, underscoring critical issues surrounding deposit behavior and interest-rate risks. It highlighted the fragility of relying heavily on uninsured deposits, particularly in an era of rapid withdrawals through digital banking. 

Most importantly, it put to test the regulations put in place after the 2008 crisis: Were they effective in this new era of banking? Have digital banking and social media fundamentally changed the landscape? And what role has monetary policy played? 

A new report led by IESE Prof. Xavier Vives examines these critical questions, as well as exploring how banking regulation can prepare for future crises. The report, titled Banking Turmoil and Regulatory Reform, calls for proactive measures to safeguard financial stability, to mitigate systemic risks, and to ensure the robustness of banking sector regulations and supervisory practices in light of recent crises. 

The sixth in a series by IESE’s Banking Initiative, the report brings together academics, regulators and the private sector — including co-authors Viral Acharya from New York University Stern School of Business, Elena Carletti from Bocconi University and Fernando Restoy from the Bank for International Settlements. It’s published by the U.K.-based Centre for Economic Policy Research (CEPR).

Also read: Why Boosting Bank Deposit Growth Is An Arduous Challenge

Regulatory effectiveness and the need for reforms 

The failures of Silicon Valley Bank (SVB) and other mid-sized banks in early 2023, along with Credit Suisse’s collapse, highlight both old and new vulnerabilities in the banking sector. The rapid withdrawal of uninsured deposits amid interest-rate hikes — made possible by digital technologies — and the reversal of quantitative easing (QE) exposed significant liquidity and solvency issues. These incidents suggest that existing regulatory and supervisory measures may not be robust enough to account for the speed and scale of modern financial crises. 

The Basel III reforms, designed in the aftermath of the 2008 financial crisis, aimed to strengthen regulatory standards. And while 2023’s failures were not due to regulatory design…