US banking sector: Stress test results compare favourably with crypto crash

Fifteen summers ago a hedge fund, sponsored by Bear Stearns and stocked with exposure to US mortgages, imploded. That would mark the start of the 2008 financial crisis that nearly toppled the global financial sector.

As a penance, the US banking sector has since been subject to strict oversight, including heightened capital requirements to mitigate the risk of any credit losses spiralling into contagion. Just last week, the Federal Reserve released the latest results of its stress test process that ultimately governs how big banks can pay dividends and buy back their stock.

The timing of these results is ironic. The current unfolding of the “crypto winter” — the price crash of various digital coins — has plunged a number of crypto lenders into their own financial distress.

On Wednesday, the Canada-listed crypto broker Voyager Digital said it could lose $650mn it had loaned to the hedge fund Three Arrows Capital. It had been crippled by the collapse in crypto prices. Voyager had been offering annual yields to depositors of 12 per cent, far above fiat money rates.

Newfangled lenders had effectively become banks by attracting crypto depositors with promises of double-digit yields. In turn these coins could then be lent out for yet other crypto schemes. Those depositors now cannot retrieve their money from outfits that were part of a movement designed to upend a supposedly obsolete Wall Street.

While banks, in a world of zero-interest-rate policy, could not offer such high returns, they did benefit from federal deposit insurance. More importantly, they have been forced to fortify themselves to prevent such panicked runs. According to Federal Reserve data, the common equity ratio of large US banks has jumped from around 5 per cent in 2009 to roughly 12 per cent, enough to absorb $600bn of losses.

Yes, banks themselves became far less attractive for their equity holders. A shadow banking industry — risk capital used for loan creation — then emerged for those seeking both higher (and safe) yields and those looking for equity returns. First came peer-to-peer loans followed by corporate direct lending funds, then buy now pay later, and forms of crypto-led “decentralised finance”. No surprise, that progression looks threatened.

There will be no government bailout for crypto platforms. Meanwhile some bank investors will lament the shackles on their institutions. They should be so lucky.