The Financial Stability Board (FSB) released a report on lessons from the March 2023 banking turmoil. The analysis finds that the three entity types most vulnerable to the confluence of solvency and liquidity risks at the current juncture are banks, life insurers, and nonbank real estate investors.
These entity types typically have a high proportion of interest rate-sensitive assets and liabilities and are affected by higher rates through various solvency and liquidity risk channels as follows:
- While most banks do not appear to be particularly vulnerable to the intersection of solvency and liquidity risks, there is a weak tail of banks that combines funding vulnerabilities and unrealized losses on their portfolio holdings, similar to what was observed for some of the banks that were involved in the March 2023 turmoil. The size of the banking sector, together with its role in funding other financial institutions, increase the importance of these vulnerabilities for financial stability.
- Life insurers’ solvency would typically be improved by rising rates, thanks to the higher duration of their liabilities relative to their assets. However, their long-dated bond portfolios expose them to unrealised losses on the asset side, depending on the accounting framework they apply. These unrealized losses may need to be realized through asset sales if liquidity pressures materialize, e.g. due to policyholder redemption demands allowed by certain life insurance contracts. In addition, some life insurers use interest rate derivatives to hedge their duration gap, which exposes them to margin calls. From an interconnectedness perspective, these forced asset sales may put downward pressure on bond prices, with negative spillover effects to other investors. Furthermore, life insurers’ investment portfolios provide significant funding to the real economy and to financial institutions, which could also be adversely affected.
- Nonbank real estate investors – comprising real estate investment trusts (REITs), real estate funds, and other nonbank mortgage lenders – can face delayed losses from higher rates since their asset valuations tend to occur less frequently, allowing for a deviation between reported asset valuations and fair market value. These investors are particularly exposed to commercial real estate, an asset class facing a number of headwinds. Leverage is used by some of these investors to boost returns, which exposes them to rising rates through the need to roll over funding. In addition, some real estate funds are open-ended and vulnerable to sizeable redemptions. Nonbank real estate investors receive a portion of their funding from entities outside their own jurisdiction, so any shocks on these entity types could be propagated across borders.
Further work to assess the identified vulnerabilities in these types of entities is being undertaken by the FSB and relevant standard-setting bodies (SSBs). The analysis of past and recent deposit run episodes in FSB member jurisdictions reveals that:
- The speed of the recent deposit runs was very high on average, unprecedented in some cases, but heterogeneous. The three fastest deposit runs in March 2023 had outflows of around 20-30% per day. This was 2-3 times faster than the highest peak one-day outflow in an FSB member survey of past deposit runs, and multiples faster than the 1% per day average outflow of past deposit runs. However, not all of the recent deposit outflows occurred at this rapid pace.
- The scale of recent deposit runs, as a share of pre-run deposits, was large and in the upper range of outflows seen in past runs. The median deposit outflow of the recent runs, at 24% of pre-run deposits, was higher than the median of past deposit runs (10% of deposits). Furthermore, in constant US dollar terms, the outflows from Credit Suisse and First Republic were greater in size than the largest historical deposit runs.
- Banks experiencing the runs tended to have an unusually high reliance on uninsured deposits. Moreover, outflows from US banks were largely concentrated in uninsured deposits, and these deposits declined in all of the banks affected by runs.
- The concentration of the deposit base likely played a role in the large outflows. The runs tended to involve banks that had a high concentration of depositors, either by type of client (e.g. high net worth individuals or wealth management clients) or by industry (e.g. start-up firms, technology companies or clients with interests in crypto-assets).