CAUSE AND EFFECT

Throughout March the global financial market was recovering from the shock and examining the aftermath of the most dramatic banking crisis in 15 years in the US and Europe.

The global financial sector lost $465bn to the bankruptcy of US banks Silicon Valley and Signature Bank. As a result, the financial position of Credit Suisse, the leading Swiss bank, also deteriorated, and the lending institution was acquired by the country's largest bank, UBS.

However, the US Federal Reserve (Fed) did go ahead with another 25 points increase in its benchmark annual interest rate to 4.75-5%. This is the highest level since 2006, when it reached 5.25% annually.

Experts believe that the negative external background can also have a certain impact on Azerbaijan's financial market, pointing out that much will depend on further developments.

Major bankruptcies

In early March, several major banks went bankrupt in the US. On March 8, Silvergate Bank, which worked primarily with cryptocurrency exchanges, crypto companies and startups, announced its liquidation. The news caused concern among investors and depositors, so they started withdrawing money from deposits at similar credit institutions.

Silicon Valley Bank (SVB), which specialised in financing start-ups, went bankrupt on March 11. It was the 16th-largest bank in terms of the volume of deposits, 87% of which were uninsured. Leading news agencies said it was the biggest bank collapse in 15 years since the 2008 financial crisis.

What followed was a classic case of Silicon Valley Bank customers rushing to collect their deposits.

The panic in markets damaged the weakened financial institutions, which have already struggled with the effects of steep interest rate rises and other problems.

Another bank finally collapsed: on March 12, US financial regulators closed down Signature Bank in New York, which specialised in cryptocurrency trading.

In addition, the collapse of SVB triggered a collapse in bank share prices on global stock exchanges. Their market value in the US, Europe and Japan fell by $459bn, with a 16% drop, the sharpest since March 2020.

In an instant, most US bank stocks lost up to 80% of their market capitalisation, while the stock exchanges even had to suspend trading operations several times to cool off the panic. The US banking sector stock index reportedly lost around 8%, including shares in Bank of America 6.2%, Citigroup 4.1% and Morgan Stanley 3.9%. SVB shares were down more than 60 per cent.

The US authorities soon announced that the Fed would provide the failing banks with funding so that they could meet their obligations to depositors in full. On March 13, US President Joe Biden delivered an emergency address and assured Americans that the country's banking system was safe and their money was safe. However, even this did not have much effect on the market, which had become very tense.

Meanwhile, the European banking sector was also affected by volatility. The Swiss giant Credit Suisse was also in crisis. As a result, it was announced that it will be taken over by Switzerland's largest bank, UBS. The deal is reported to be worth $3.2bn. Societe Generale and Deutsche Bank AG, although under pressure, remain resilient.

According to ECB head Christine Lagarde, Europe now has the necessary tools to avoid a crisis like the one in 2008. In addition, the European banking sector is now in a much stronger position, she stressed.

However, amid financial turmoil and a series of bank failures, the central banks of the UK, EU, Canada, Switzerland, Japan and the US Federal System have agreed on coordinated action to increase the supply of dollars on the market.

The high stakes

In the meantime, experts are increasingly focusing on the main reasons behind the ongoing unpleasant situation on the western financial market. One of such reasons is the accelerating inflation in the US economy that forced the Fed to tighten its monetary policy, leading to the depreciation of debt securities of banks. As a result, start-ups - SVB's main customers - started withdrawing money from their deposits.

The ultra-soft monetary policy implemented by the Fed over the past two years to stimulate the national economy in a pandemic environment has encouraged investment in technology ventures. And the sharp rise in interest rates has led to an outflow of investor money from the overheated tech sector, as well as a drop in bond values. In addition, when the key rate rises, new bond issues also have higher interest rates, meaning they become more attractive to investors, while older issues with lower interest yields become cheaper. In addition, deposit rates should rise as well. In short, it becomes profitable for clients to take money out of old deposits at a low interest rate and put it into new accounts at a higher rate.

However, despite such dramatic consequences for the banking market, on March 22 the Fed raised the federal funds rate again by 25 basis points to 4.75-5% annually. This is the highest level since 2006, when the rate reached 5.25% p.a.

"The US banking system is sound and resilient. Recent events are likely to lead to tighter credit conditions for households and businesses and have an impact on economic activity, employment and inflation. The extent of these effects is unclear. The Committee continues to monitor inflation risks extremely closely", the Fed press release said.

However, most analysts had predicted this course of events - rising inflation is much more dangerous for the economy than bank failures. According to experts, the US regulator has chosen the right stance, preferring to curb the growth of consumption to bail out financial institutions.

Note that in its latest statement the Fed raised its US inflation forecast for this year from 3.1% to 3.3% and kept it at 2.5% for 2024. GDP forecasts for this year and 2024 were worsened from 0.5% to 0.4% and from 1.6% to 1.2%.

Earlier it was reported that the growth in consumer prices in most countries in the Middle East and North Africa will exceed 10% in 2023. This inflation was predicted by the Managing Director of the International Monetary Fund (IMF) Kristalina Georgieva, the organization's press service published the text of the statement on its website.

She noted that for emerging market and low-income economies in the region, such a price increase reflects, among other things, the depreciation of national currencies.

To retain and preserve

The global trend towards higher interest rates has not spared Azerbaijan: the Central Bank (CBA) raised it by 25 basis points to 8.75%. This is the fourth increase in a row. In the information released on March 29, it was noted that the lower threshold of the interest rate corridor was increased from 6.75 to 7%, the upper one - from 9.5 to 9.75%.

It is encouraging that amid global trends the Azerbaijani regulator does not expect a rise in inflation and continues to keep the forecast within 8%. "In February 2023, annual inflation in Azerbaijan was 14.1%, 1.5 percentage points below the peak of 15.6% in September 2022," CBA said in a statement on the discount rate.

At the same time, the regulator notes a decline in inflation from the local market peak. The FAO (UN Food and Agriculture Organisation) has also cited declining food prices over the past 11 months as a contributing factor to keep it in single digits.

These are the highlights of the positive scenario. There is also a negative scenario. It is possible if the demand for liquidity in the economy grows in the context of a stimulative fiscal policy and rising foreign exchange earnings in the country. The CBA notes that the non-oil sector continues to grow at a high rate, which is shaping this demand.

On the other hand, inflation can be adversely affected by the revision of a number of tariffs for state-regulated goods and services from the beginning of 2023.

In order to prevent a negative scenario, on February 23 the CBA increased the quota for overnight deposits in order to increase the efficiency of sterilisation operations and also started to carry out 7-day repo transactions. Also, in order to effectively regulate the money supply, all banks started to keep required reserves in accordance with the new norms effective since February 2023. As a result, in March the amount of mandatory reserves that banks have to keep in manat increased by 57% compared to January.

All these instruments should strengthen the impact of the discount rate on inflation, keeping the economy in balance. "We are trying to conduct our policy so that our desire to keep inflation at the target level does not negatively affect economic activity in the country," Head of CBA, Taleh Kazimov, said.

But again, much will depend on the external environment. Although there is no direct impact of the banking crisis in the US and Europe on the Azerbaijani economy, should the negative trends in the West deepen, the scale of the global defeat would widen. In any case, the CBA will face difficult months in monitoring the process and preparing preventive measures. Just to be on the safe side.