Banking on the Brink of Crisis? Three Scenarios for Investors

While the broad equity market remained relatively resilient in the wake of bank failures and banking stocks’ subsequent plunge, the big question for investors remains: Will the recent problems exposed in the banking system escalate, potentially spill over to other industries and weigh on markets in the coming months?

History never repeats itself, but it often rhymes

In response to the 2008 global financial crisis, significant new legislative and regulatory actions were taken to improve bank capital and reduce the likelihood of another banking crisis. The recent failure of Silicon Valley Bank, seizure of Signature Bank and regulator-driven takeover of Credit Suisse AG, however, serve as warning calls to investors that the banking industry may not be as safe as previously thought.

We present three scenarios for potential risks and opportunities emerging from the recent upheaval in the banking industry.¹ Under our “banking crisis with weaker policy intervention” scenario, financial-sector stocks could sell off further, with spillovers to broad equities (although portfolio allocations to government bonds may partly cushion those losses). Under a scenario with stronger policy intervention, government and investment-grade corporate bonds could benefit from the larger decline in yields, while equity-market losses might be more muted. Finally, if a larger banking crisis is averted, bank stocks have the potential for a greater rebound, but bonds could experience losses due to nominal yields’ reversal to higher levels (see second exhibit).

The authors thank Dora Pribeli for her contributions to this quick take.