Bank turmoil and energy markets

There have been mounting concerns over the stability of the global banking system after the failure of Silicon Valley Bank and the rescue of Credit Suisse. Listen to a discussion on the causes of the turmoil and what may happen next. Are we in danger of a broader banking crisis, and what could the consequences be for the energy sector and the rollout of renewables? 

Host: Richard Sverrisson, Editor-in-Chief, Montel 

Guests: Thina Margrethe Saltvedt, Chief Analyst, Sustainable Finance, Nordea and Lucy Eve, Senior Strategist, Eurasia Group

Transcript

Richard Sverrisson, Editor-in-Chief, Montel: 0:06

Hello listeners and welcome to the Montel Weekly podcast, bring You Energy Matters in an informal setting. Over the past few weeks, concerns have grown over the stability of the global financial system in the wake of the failure of Silicon Valley Bank and the rescue of Credit Suisse by UBS. What is the roots of the turmoil and could it trigger another global banking crisis? What are the consequences for the energy sector and the rollout of renewables? Could the energy transition be slowed down by increased costs of financing projects? Helping me, Richard Sverrisson to discuss what's happening in the global financial sector are Lucy Eve of Eurasia and Thina Saltvedt of Nordea Bank. A very warm welcome to you both.

Lucy Eve, Senior Strategist, Eurasia Group: 0:47

Thank you, Richard.

Richard Sverrisson, Editor-in-Chief, Montel: 0:48

Let's start with you, Lucy. What happened to Silicon Valley Bank and Credit Suis? Were the same root causes here?

Lucy Eve, Senior Strategist, Eurasia Group: 0:53

So I think there are several factors that make Silicon Valley Bank an outlier and that led to its collapse. Firstly, the bank's clients were very concentrated in the US tech startup space, which meant that they had very little diversification when conditions got tougher for their core clients in a higher interest rate environment. They had a very large share of uninsured deposits, which made them a lot more vulnerable to deposit outflows. And on top of that, their assets were very concentrated in long-term bonds, which had low credit risk, but on which they had experienced substantial unrealized losses. On the back of those rise rapidly rising interest rates. Normally absent big deposit outflows, the bank would've expected to be able to hold those assets and those bonds on their books until they matured and would very likely be repaid in full on those assets. However, what we saw in a environment of rapidly rising interest rates and rapid deposit outflows, they were forced to rapidly sell those bonds to meet those outflows, and that locks in losses for them. In many ways, Silicon Valley Bank was an outlier given it had a very high share of uninsured depositors and a very concentrated client base. On top of that, they had poor risk management of the bank's interest rate, risks, and losses on assets that were equivalent to a very large share of their tier one capital. So though there are other small and medium sized banks where there is some similar concerns about that flight of deposits and the unrealized losses on those held to maturity assets, there's also no guarantee that we could return to low inflation after a period where interest rates were low and markets for were forgiving for so long. So we're likely to see tighter global liquidity conditions. On the back of that. So overall we would think that the Credit Suisse situation is quite different to that. While the Credit Suisse crisis was brought about by this global anxiety about bank stocks following the collapse of Silicon Valley Bank and which the crisis in Credit Suisse was accelerated also by the bank's biggest shareholder, Sally National Bank, saying that it wasn't willing to provide further support. That said credit suisse's problems go a lot further back than that. So Credit Suisse has suffered from a series of scandals, risk management issues, and have been a big underperformer for some time with big question marks around its profitability for a while. And that all came prior to the Silicon Valley Bank developments and to the rapidly rising interest rate environment. Similarly to Silicon Valley Bank. They also saw a very rapid withdrawal of deposits. But instead it was from their wealth management clients. And that was really what triggered Swiss officials to need to step in. So in terms of the commonalities that we can see there, concerns about higher interest rates and its impact on the bank's business models as well as poor risk management and sharp deposit outflows were factors that were in common at both banks. Even if the business models or exact causes of the collapses were somewhat different.

Richard Sverrisson, Editor-in-Chief, Montel: 3:51

Excellent. Thank you for that summary. Lucy, if I can turn to you, Thina, you work in a bank are people very concerned?

Thina Margrethe Saltvedt, Chief Analyst, Sustainable Finance, Nordea: 3:56

I think they are a bit concerned because the market volatility has increased a lot and because you have seen Central Bank trying to stabilize it and still, the volatility is there. So I think what you're worried about is how long does it last for? What should actually take it to stabilize a bit more?

Richard Sverrisson, Editor-in-Chief, Montel: 4:16

Absolutely. Lucy, these, this is in California and Switzerland. These are, these are, robust economies, well-functioning countries. They're not unstable countries at all. Could the term are spread beyond that, do you think?

Lucy Eve, Senior Strategist, Eurasia Group: 4:26

I think absolutely. We're not talking about emerging markets or highly highly indebted, vulnerable, emerging market economies. Here we are talking about the US and Switzerland. But I think what these episodes have shown us is that confidence in banks and investor faith in the security of their deposits can really evaporate very quickly. So under normal market conditions, we would assume that. Deposits in particular retail deposits and especially those that are insured do prove to be quite sticky in normal market conditions. But clearly that can change overnight very quickly if there's investor panic. So I think we've seen this very rapid and large tightening in global monetary policy and we're still seeing sticky inflation. So that does mean that interest rates are likely to remain high for some time, even if we are seeing markets start to price in more of an easing towards the second half of the year. And that environment of still high interest rates for some time does pose a risk to bank's profitability and a risk of further deposit outflows as depositors look for better paying alternatives than the returns that they're getting on bank deposits. On top of that, we also have the fact that monetary policy tends to operate with a lag. So it's not clear that we've yet seen that cumulative impact of all of the rate hikes and monetary policy tightening actually flow through and fall to the real economy. So I think on the back of all of that, we're unlikely to have seen the end of the crisis and we would expect markets to continue to test these perceived. Weak links in the system.

Richard Sverrisson, Editor-in-Chief, Montel: 5:54

And the weak links, would they be within banks, regional banks smaller bank, not the, there were even jitters around Deutsche Bank last week.

Lucy Eve, Senior Strategist, Eurasia Group: 6:02

Yeah, so I think if we're talking about the biggest, most systemically important banks, we're in a very different situation to how we were prior to the global financial crisis and the European sovereign debt crisis. So those bigger, big, systemically important banks. Are much better capitalized than they were pre-crisis and should be relatively resilient. But I think we do, we are still likely to see some stress that some of the smaller and medium sized US banks, I think one particular focus is their exposure to US commercial real estate. So that, that would be one watch point that we are cla carefully looking at in terms of the con potential contagion from that sector to the balance sheets of some of those smaller regional banks. So I think if we see a more rapid pullback on commercial real estate commitments and losses on some of those assets we could see that drive continued concerns about that sector. I think if we're thinking about the European outlook as well, European capital and liquidity buffers are in a much position again. Then they were prior to the financial crisis and the European sovereign debt crisis. I think as we can see from the recent pressure on Deutsche Bank, a bank where profitability and capital buffers are a lot stronger than where they were at Credit Suisse and with overall a lot stronger fundamentals. Investors are likely to test other banks and look to hedge their exposures to the European banking sector more broadly. So even though we think that fundamentals are much stronger now we may well see more pressure to come.

Richard Sverrisson, Editor-in-Chief, Montel: 7:28

Now before I, I turn to Thina and ask more about the impact on the energy sector. If I can ask you, Lucy, the rescue of Credit Suisse by UBS what does this say about the reputation of Switzerland? Has it come out of this tarnished?

Lucy Eve, Senior Strategist, Eurasia Group: 7:40

So I think the structure of the deal itself was controversial in several ways. I think one of the core challenges and controversies regarding the deal was the treatment around 81 or additional tier one debt. Now that's expected to be or intended to be the riskiest type of debt in the capital structure and to be conversed into equity if a bank's capital ratios fall below a certain level. And that debt was written down to zero in the case of Credit Suisse, but what was controversial about the deal is that. Equity holders, which are meant in theory to absorb all of the losses before debt, including the 81 debt is hit, will still receive some recovery value as part of the deal. So that decision that was made does upend this traditional capital structure by giving those equity holders preferential treatment to the bond holders. And that has led to contagion in the broader European 81 market. So I think in terms of the crisis response and the reaction by other regulators in other countries. EU and UK regulators did welcome the fact as, as well as the US that Swiss officials stepped in to broker a deal between UBS and Credit Suisse, but they did distance themselves from that critical element of the plan on the treatment of 81 debt. So they've reaffirmed their stance that bank equity holders should take losses before 81 holders, in contrast to the Swiss move as they've looked to try and contain that broader spillover to European banks. But I think there's really some still lingering frustration among EU policy makers that confidence in 80 ones, which were developed post the European debt crisis and global financial crisis as a new tool that was meant to strengthen European bank balance sheets and act as a buffer in terms of crisis, was so rapidly undermined by the move by specific officials.

Richard Sverrisson, Editor-in-Chief, Montel: 9:27

But Switzerland, obviously not in the EU either.

Lucy Eve, Senior Strategist, Eurasia Group: 9:29

Yes. And I think that it's not just frustration on the European side, but. The fact that regulators sidestep the need for a shareholder vote was quite frustrating for some. And also there are a lot of unhappy investors in the Gulf. So I think it comes as a political black eye in particular for some of the Saudi and Qatari investors that recently invested large stakes in those companies and will be nursing steep losses on the back of that.

Richard Sverrisson, Editor-in-Chief, Montel: 9:54

Oh, excellent. Thanks for that explanation. Listen, I think, but what, Thina, what does this mean for the energy sector and particular for the green transition? Obviously the cost of capital is gonna increase, obviously. Liquidity could be an issue. But have you seen any consequences already?

Thina Margrethe Saltvedt, Chief Analyst, Sustainable Finance, Nordea: 10:07

I think in the short run it's often that you see that investors pull out of commodity markets as such, when uncertainties moving up, this is what we have seen during the earlier crisis, late banking crisis and the financial crisis in 2008. We saw that during the York crisis in 2014. So when the volatility is increasing many sell out of the commodity markets, often seen as more more risky markets than a few other markets. That is what we have seen. We've seen commodity prices dropping a bit as well, but I still think, it might be short term because, the development we have seen in the energy markets, often more longer term investments you do are more longer term. And of course if you talk about renewables, we had seen a completely different situation, at least for the last year with the war in Ukraine and the need to search for energy sources that is not linked to Russia for example. So I think, it's not unusual to see this kind of sell off in the very, very short term, but I'm not really sure how long it lasts for because I think investors will be willing to go into, especially in Europe, into renewables again quite soon when the market stabilizes.

Richard Sverrisson, Editor-in-Chief, Montel: 11:24

So when you say a sell off, that's me mainly. We've seen an oil's been the main driver here that's been falling or in the last. Two weeks affected by the this banking crisis.

Thina Margrethe Saltvedt, Chief Analyst, Sustainable Finance, Nordea: 11:33

Sure. I think oil we are also seeing that energy prices such as natural gas has been falling, but that's been lasting for a bit longer. So you both have the macroeconomic situation. Which saying that we go into a period of time during the year when we don't need that much energy. And that has of course, helped as well to slow down the prices because we're going into the spring season where temperatures are rising at the same time, it was, it has been discussing if actually how would the effect be when China opens up. A bit more after the COVID closed down. And so far we haven't really seen that, that has been pushing up the the energy prices very much. So I think, this kind of crisis going in this type of turbulence. I would rather say it's too, if you say it's a crisis in the banking sector, but the tur. Hitting the banking sector has of course hit, all investments and I think it's a bit risk off at the moment.

Richard Sverrisson, Editor-in-Chief, Montel: 12:32

Exactly. Do you think then it could delay or slow down the deployment of renewables in Europe or as you say, it's, that's more of a long-term investment and. Maybe that could not be so affected.

Thina Margrethe Saltvedt, Chief Analyst, Sustainable Finance, Nordea: 12:44

I think still, the mar, it's a bit too early to say, because if this lasts for a couple more weeks and then it's quite stone, I think it wouldn't have affected investments in renewables that much. And the reason why is that Europe especially is so keen on building up or getting less and less dependent on the Russian Russian. Oil and natural gas. So I think it's needed to make these investments of other reasons that, these pure speculative cha changes. Also we have seen that the US for example with the with the IRA coming in the competition is increasing between China, the US, and the Europe. Who's going to take the the lead of driving the renewables. Investments. So I think still, it takes a bit more than a few weeks of turbulence to actually stop it. It could actually slow it for a, for still weeks. But in the longer term, I think it's, I think the willingness to invest in renewables of political reason are quite high at the moment.

Richard Sverrisson, Editor-in-Chief, Montel: 13:52

Yeah. And there's quite a lot of money swirling around. You mentioned the us, the Inflation Reduction Act, and also there's a lot of subsidies available in Europe and elsewhere. But do you think you could see more consolidation in the renewable sector where, smaller players could get hit by this sort of, could hit their sort of credits ratings here? Or their ability to be able to fund such large, a large or make large investments into green energy?

Thina Margrethe Saltvedt, Chief Analyst, Sustainable Finance, Nordea: 14:14

It might be, and I think also it's still a bit early to. To see that. But of course the recent increase in interest rates, of course put more pressure on the smaller smaller actors within this space. So of course it will be interesting to follow that at least this spring and the upcoming summer.

Richard Sverrisson, Editor-in-Chief, Montel: 14:31

But the banking turbulence, as Thina calls it Lucy not quite a full, fully blown crisis yet. I agree. Has there been a failure of regulation?

Lucy Eve, Senior Strategist, Eurasia Group: 14:40

I think if we look at the Credit Suisse situation from and what caused that crisis, I think that stems from longstanding problems with profitability, with governance issues, and a series of scandals. And their management had also struggled to articulate a convincing turnaround plan for investors, which meant that confidence quickly evaporated. If we look at the crisis response by regulators and officials for all the reasons that I mentioned before, question marks will be raised about the fact that the post global financial crisis and post Euro zone debt crisis playbook was thrown outta the window in the Credit Suisse and UBS deal. And they wouldn't, they didn't follow the rules that had been developed post. That period to try and improve the resilience of the European banking system? Yes. They stepped into. To prevent that broader contagion. And that was welcomed broadly. But I think there will be question marks going forward about exactly how they responded. And that does pose a risk of potentially undermining confidence in the Swiss response to financial crisis situations and the implications of what that means for European debt investors.

Richard Sverrisson, Editor-in-Chief, Montel: 15:49

What do you think, Thina? What should. Policy makers or regulators do in the current crisis? Just keep a cool head or, what would you be, your suggestions or advice?

Thina Margrethe Saltvedt, Chief Analyst, Sustainable Finance, Nordea: 15:58

I think it's important that they're out there saying that we will support you, we will support banking sector so you don't get this panic situation and this bank runs. Because in the medium term, it's if you. If you want to stabilize the markets and the central bank is saying that, okay, we will support you during in this in this turbulence then I think, that should calm it down. If you don't find any, other banks or other banks that will have problems. So I think it will. Starting to cool down if you don't see anything more coming up soon.

Richard Sverrisson, Editor-in-Chief, Montel: 16:31

What's your view here, Lucy? What should regulators do?

Lucy Eve, Senior Strategist, Eurasia Group: 16:34

I absolutely agree with Thina. I think Affirm and Swift response by the Fed, by central banks, by officials to try and restore confidence is key here. And I think the speed and the spread of the recent turbulence. As Thina says, does underscore that now is not a time for complacency and that this rapid action by policy makers can really do a lot to stabilize market conditions and the net contagion. So I think the new facility that we've seen from the Fed and the moves to guaranteed deposits in the failed banks in the US did do a lot to prevent that. Much broader spread to a wider range of banks, even if we still have seen some substantial underperformance in some of the regional banks that that investors see as more vulnerable. So I think in terms of what regulators will be looking at next, I think the regulation of small and medium sized banks is one area that people are focused on. And the move that was made during the Trump administration to roll back some of those regulations that were impacting those small and medium sized lenders. So I think there will be a rethink about, potentially about the regulation that's applied to some of those banks and in the UK as well. There had been in December a push by the government to push through some new reg, a lighter regulatory environment on some of the smaller UK banks, and I think it's likely we may see some sort of a rethink or a watering down of some of those proposals. So I think that the regulatory regimes have been strengthened a lot in the last few years. But one area that we think is potentially incomplete still is the discussion around a banking union in Europe. So I think this will provide a new impetus for those discussions. And the debate around, exactly how unsecured depositors should be protected and the resolution plan for some of the smaller banks will be also at the more discussion.

Richard Sverrisson, Editor-in-Chief, Montel: 18:22

Yep. Excellent. Thina, you've mentioned earlier the impact on some commodity prices. It's been, we've seen commodity prices falling, given the net zero targets and the very, the sense of ambition in Europe to green the economy to move to the end transition. Is there a danger that some countries or regions could turn back to coal and gas amid these falling prices?

Thina Margrethe Saltvedt, Chief Analyst, Sustainable Finance, Nordea: 18:44

There are al always a bit of risk that some some of the countries that used to produce much more coal than they're doing at the moment could turn up up these in the very short term. I don't think, in the longer term that should be problem. Mainly because I think that they will require new investments soon as well to keep the coal production going or the coal industry going. So I still hope, I would say also that I think this is a short term challenge rather than medium term and longer term challenges because we're seeing that the CO2 prices. Still are quite high. They moved up and they're still, still keeping up there. At the same time the EU want to or they have actually pushed investments in in the greener industries. And so they try to support that move. So I still think that it's too early to say that, this this green wave, we saw the starch of last year. Has stopped completely. But of course if this continues for a long period of time, that could have a negative impact on the green chance transition. But I still think it's too early for that.

Richard Sverrisson, Editor-in-Chief, Montel: 19:57

Yeah. So as you say, Thina, it's just a temporary blip really, but we have to wait and see, what happens if it does burn? Go from turbulence into a full blown crisis, then obviously things would be slightly different or very different, in fact. But what's your outlook on the commodity prices for the coming weeks and months here, genome, oil and gas and carbon.

Thina Margrethe Saltvedt, Chief Analyst, Sustainable Finance, Nordea: 20:15

In the very short term, I think, as you're seeing temperatures are rising in Europe in Northern Europe as well. I think we need to see that this turbulence in the in the banking sector will need to calm down if prices are going to move up again. And interesting to see what will happen with the inflation, the pressure on the economies as well. Because if you're seeing that real economies are, slowing down as well, that would have an impact on the demand for energy. Economic growth is the biggest driver of the demand for energy as such. If higher inflation and this turbulence in the in the banking sector is dragging on, then I think you will see that common to prices could slow down from the current level as well.

Richard Sverrisson, Editor-in-Chief, Montel: 21:02

What's the view from Eurasia here on the impact on the EG sector Lucy more generally?

Lucy Eve, Senior Strategist, Eurasia Group: 21:06

Sure. So I think if we're talking about the impact of the recent strains in the banking system on the real economy, it's clear that we are going to see a tightening in credit conditions as banks are more focused on their own financial health. But it's unclear at this point exactly how much of a effect that's gonna have and what the impact's going to be on the real economy. One thing that has been quite unique about the recent situation is the continued strength that we've seen in the labor market despite the cumulative rate hikes. So while we've seen all of the volatility in the banking sector, that hasn't really translated into a significant. Uptick in unemployment and labor market conditions are still quite tight. So I think we are yet to see the full impact of the cumulative hikes and that credit tightening on job market data, which makes it harder to assess what the exact impact is gonna be on commodity markets. Clearly we've already seen a big reaction in the oil price and a substantial decline there. But I think it's too early to see, to say how long that will be sustained for, given the amount of uncertainty around exactly how impacted credit conditions are going to be and how much that will therefore flow into consumer confidence and actual activity. In terms of the services sector, manufacturing and the impact that has on commodity markets more broadly.

Thina Margrethe Saltvedt, Chief Analyst, Sustainable Finance, Nordea: 22:31

And could I add something there as well, because of course the crisis in Ukraine and around Russians influence on the European commodity markets, we haven't seen the end to this of course. And we don't still not know the full impact of how the sanctions against. The Russian commoni markets and, the latest implications of oil products and natural gas will have on the total market will be seeing that the Russian oil production and or CR oil and products will go to another harbor to go to the east, for example. Or do we expect that more is going to disappear from the market? We don't still know that effect. Potentially an impact on the prices going for forward as well this spring and summer.

Richard Sverrisson, Editor-in-Chief, Montel: 23:20

Absolutely. It's early days and let's let's hope it, it is, as you described, Thina, a blip rather than a fully blown crisis. But Lucy and Thina, thank you very much for joining the Montel Weekly podcast. Listeners, you can now follow the podcast on our own Twitter account, aply named the Montel Weekly podcast. Please direct message. Any suggestions, questions, or, let us know if you think you have a good idea for a guest on the show, you can also send us an email to podcast@montelnews.com. Lastly, remember to keep up to date with all that's happening in energy markets on Montel News. You can subscribe on Apple Podcasts and Spotify or wherever you get your podcasts from. Thank you and goodbye.