Stock - Bitcoin/ Crpto crash/ cryptocurrency
o the numbers on global systemically important banks and they are in solid territory. Image Credit: Shutterstock

Liquidity is drying up in the global financial system. Large banks are making headlines for being on the brink of collapse, and authorities continue to intervene in markets.

We look to summarise the state of the banking sector as it stands and quantify their exposure to cryptocurrencies. In doing so we show how vulnerable digital asset markets might be to a tail risk event.

Banks today operate in a very different environment to 2008. Despite headlines raising concerns about a Lehman Brothers equivalent bankruptcy for certain banks, the sector as a whole does not seem to be at risk of imminent collapse. Various metrics can be looked at to assess this.

Common Equity Tier 1 ratio (CET1) takes core capital including reserves and divides it by the bank's risk weighted assets. By adjusting for risk, different exposures can be accounted for. Mortgages or derivative exposures for example, would be considered riskier than cash.

The average CET1 ratio for the largest banks across the UK is currently 15.3 per cent, 15.4 per cent in the EU, and 13.4 per cent in the US. Basel III, an accord developed by the Basel Committee on Banking Supervision in response to the 2008 crisis, requires the CET1 ratio to be at least 4.5 per cent.

Looking to another measure, the Net Stable Funding Ratio (NSFR) is defined as the amount of available stable funding relative to the amount of required stable funding, over a period of a year. This ratio is required to be over 100 per cent, and designed as a liquidity standard that conveys the probability that external shocks might affect a bank’s sources of funding, which in turn influences its liquidity position. The average NSFR for European bank is is currently at 126.9 per cent.

Of all the banks, Credit Suisse is attracting the greatest scrutiny and attention. The bank is indeed distressed and set to undergo restructuring, but comparisons to Lehman Brothers are perhaps undue.

Looking at Credit Suisse’s balance-sheet compared to Lehman Brothers balance sheet in May of 2008, we extract a few notable differences. Credit Suisse’s CET1 ratio is currently 13.5 per cent, whereas Lehman Brothers’ was close to 5 per cent. Credit Suisse’s exposure to securities is 31 per cent of total assets, whereas 88 per cent of Lehman Brothers’ assets were security positions, with a significant amount being collateralised agreements.

This is a strenuous time for banks. Rising interest rates are thought to be favourable for lenders, but lenders favour a steep yield curve (long term rates higher than short term rates).

Banks are in the business of borrowing short and lending long, and so an inverted yield curve, as we currently have, is sure to reduce profitability for the sector in general.

Banks’ exposure to cryptocurrencies

During periods of substantial market stress therefore, when banks and institutions tend to sell assets to meet current obligations, digital assets, it seems, are well insulated.

Indeed the market action over the past few months has confirmed this. Bitcoin volatility has reached lows not seen since 0ctober 2020, and is trading sideways, while traditional markets have shown considerably more volatility. Perhaps most importantly, treasury market volatility has been rising and has reached Covid-pandemic levels. We see a normalised chart of Bitcoin and S&P 500 volatility, compared to bond market volatility (MOVE Index), to illustrate this change of scene. This is typically a dire sign, as when the treasury market is dysfunctional, market stress tends to be severe.

We notice that while Bitcoin is traditionally the more volatile asset, its volatility has been lower than the bond market and S&P 500 for much of 2022. We are not of the stance that the bottom is definitively in for cryptocurrency assets, and a major market event would almost certainly extend to digital ecosystems.

There are marked economic risks, and according to the bank of international settlements, banks like Credit Suisse are on the list of globally systemic important banks (GSIP). Should the collapse of a major bank materialise, it would undoubtedly shock global markets and would likely see cryptocurrencies trade lower.

However, with limited bank exposure and a largely washed-out system, our views are that much of the selling has been exhausted, and further pain would be temporary.