This sent shockwaves throughout the continent, and other commercial banks such as Deutsche Bank in Germany and UniCredit in Italy saw their stock prices suffer severe sell-offs.

Patrick Lenain, Senior associate Council on Economic Policies

The situation had the potential to spiral into a full-blown financial crisis. Thankfully, central banks and regulators across the globe were able to intervene promptly and successfully stop the contagion. Since then, bank share prices have partly regained lost ground, credit default swaps have retreated from peak levels, and large-scale deposit flight has ceased.

Four crucial lessons can be learned from this experience.

The first lesson is that each crisis is different. The global financial crisis of 2007-2008 was a credit crisis: US banks failed because they negligently extended massive mortgage loans to sub-prime home buyers, who failed payments when the US Federal Reserve hiked interest rates. Since then, regulators and bankers have paid much attention to credit risk.

However, the present crisis did not originate from credit risk. It was interest rate risk that brought down banks in March. During the long period of ultra-low interest rates, banks have accumulated long-dated bonds to generate income. They were paying attention to credit quality, but did not foresee the massive losses on their bond portfolio if central banks tightened their monetary policy – as they have done since 2021.

Policymakers had clearly communicated that interest rates would be rising quickly, yet some institutions were simply unprepared for the higher rate environment.

In its new Global Financial Stability Report published on April 11, the International Monetary Fund estimates that “the impact of unrealised losses in held-to-maturity portfolios for the median bank in Europe, Japan, and emerging markets would likely be modest, although the impact for some other banks could be material.”

The second lesson is that digital banking has brought forth an unforeseen consequence: increased risk of bank turmoil.

This was made abundantly clear by the recent bank turbulence, which was exacerbated by the widespread prevalence of social media and digital banking. Rumours spread like wildfire on social media, prompting worried customers to withdraw deposits worth billions of dollars and Swiss francs with just a few taps on their smartphones.

The panic was so intense that customers withdrew as much as $42 billion from SVB on March 9, leaving the bank unable to cope. Credit Suisse also experienced a massive flight of deposits. In light of these events, regulators must be prepared to act swiftly and decisively to restore market confidence and prevent panic from spreading.

Vietnam has already set an example of how to handle bank panics. In October 2022, Saigon Joint Stock Commercial Bank, the fifth-largest privately owned commercial bank in the country, faced a bank run that resulted in long queues outside its branches. However, the State Bank of Vietnam (SBV) stepped in and handled the situation with remarkable ease, assuring depositors that their savings were guaranteed and swiftly restoring market order.

This type of rapid intervention demonstrates that the central bank is well-prepared to manage sudden waves of panic, providing much-needed reassurance to customers and investors.

The third lesson is to prepare for the next crisis, which might come from an unexpected surge of inflation.

In Vietnam, the pace of inflation has eased, with only 3.55 per cent in March, comfortably below the central bank inflation target of 4.5 per cent. This has encouraged the SBV to lower its benchmark refinancing rate by 50 basis points from 6 to 5.5 per cent on March 31, the second rate cut in a month.

An unexpected surge of inflation still poses a threat. Geopolitical tensions could cause commodity prices to soar once again, resulting in a sudden surge in inflation. Thankfully, central banks have learned to manage these challenges with greater efficiency.

In the past, central banks would cut interest rates to address banking turmoil, thereby sacrificing their inflation objectives. This is no longer the case. The European Central Bank managed to increase its policy rate by 50 bps on March 16, despite the banking turmoil. A few days later, the Fed raised its funds rate target by 25 bps, brushing off concerns about the banking system.

Vietnam’s central bank should consider developing similar capacities, including new tools to support banks in times of turmoil while also tackling inflation.

The final lesson is that banks remain too fragile. Much has been done by supervisors to strengthen oversight, such as more capital requirements, larger liquidity buffers, and regular stress tests. Bank supervisors are well-prepared to intervene quickly with resolution plans to protect depositors, bail in shareholders, and impose mergers with other institutions, all within a matter of days and reopening after a short weekend.

Nonetheless, the events of March show banking turmoil can still occur, with a disruptive impact on the prosperity of countries, particularly those striving for balanced economic growth like Vietnam. Although banks play a crucial role in intermediating savings and investments, they do not provide the full protection of citizens’ savings. Too many banks remain mismanaged, with an excessive risk-taking using the funds of their customers.

It is time to consider a new financial system that can offer a simpler, more prudent, and stable banking sector for commercial payments and savings protection, separate from volatile and risky financial markets.