The real issue behind recent banking turmoil

Oksana Patron

29 March 2023

The tight credit conditions inflicted on economies and the constriction of credit supply induced by central banks is the ultimate culprit of the recent banking turmoil, according to Franklin Templeton.

Andrew Canobi, Director Franklin Templeton Fixed Income team in Melbourne, and portfolio manager for the Franklin Templeton Australian Absolute Return Bond Fund, noted that although it was highly unlikely that the markets would face another banking crisis in the Global Financial Crisis (GFC) style, the recent tremors from the banking world exposed idiosyncratic weaknesses.

The risk still remained that markets would focus on the headlines and would miss the bigger issue.

“The real issue that lies behind the banking turmoil is the constriction of credit supply that central banks are inducing amidst their assault on inflation. The constriction of credit, and withdrawal of liquidity,
ultimately finds out the weaknesses in the system. The supply of credit supports growth and drives inflation. Just as the excess creation of money through the pandemic caused inflation to surge, its rapid
destruction as central banks shrink the money supply is highly disinflationary,” Canobi said.

“The franchise and confidence in the institution might be irreparably damaged but liquidity crises can be solved with the flick of a switch per the headline above,”

“Arguably, the demise of Silicon Valley Bank owes its genesis to the dramatic shrinkage of capital being made available to the private equity, start-up and tech sectors which made up the bulk of SVB’s customer base.

“As credit has been drained from the system and liquidity become scarce, funding markets for start-up ventures has dried up. What do you do then? You draw on your liquid bank deposits.”

At the same time, in Australia, the impact of tighter credit conditions at the hand of the Reserve Bank of Australia (RBA) was centered on construction and building.

“More than 1200 firms in that sector have entered receivership, liquidation or administration this financial year so far,” Canobi said.

“It’s never been weaker outside the GFC. This isn’t surprising, as no-one can afford to buy overpriced houses at current interest rates.”