Banks and Financial Crisis
By Colin Fahey, Vice President, Commercial Banking, The National Bank of Indianapolis
Given recent bank failures and subsequent turbulent environment, the term “financial crisis” grabs our attention. So, what exactly is a financial crisis and how do banks typically react during this time?
A financial crisis is a time of great stress and uncertainty in the economy, marked by a sharp decline in the value of assets, significant contraction of credit and liquidity and increased risk of defaults and insolvencies. During such times, banks can play a critical role in stabilizing the financial system and mitigating the adverse impact on individuals and businesses. However, the stabilization efforts taken by some banks can be painful. To ensure that you are working with a financial institution that can ease that pain as much as possible, consider a bank’s liquidity, risk exposure and overall capital.
First and foremost, during a financial crisis, banks must make certain that they maintain liquidity in the financial system. Banks must ensure that they have enough cash and liquid assets to meet the demands of their depositors and borrowers. Occasionally, they may also need to borrow from other banks, the central bank or other sources to maintain liquidity and avoid a liquidity shortfall. This lack of liquidity was a significant culprit in the recent bank failures.
Second, banks must carefully assess their risk exposure to different sectors and markets. They need to review and manage their credit, market and operational risks to minimize losses and prevent contagion effects. Banks may also need to revalue their assets, conduct stress tests on their loan portfolios and adjust their risk-management strategies. It is through these efforts that some banks may ultimately decide to exit certain markets or credits that they feel present too much risk. This exit strategy can have a huge negative impact on a local economy and/or a particular business sector. Therefore, it is imperative for individuals and businesses to know their bank and banker and fully understand their bank’s position in times of stress.
Third, banks need to manage their overall capital. As previously noted, liquidity is paramount for a bank during a financial crisis given their clients’ cash needs. Therefore, a bank may need to reevaluate its investment strategy to increase more liquid assets, decrease or eliminate dividends, issue new shares of stock or reduce overall leverage. These activities may ultimately result in greatly reduced credit and lending appetite. So, in a time when business and individuals may need access to loans, the bank they work with may not be able to help.
Banks are vital to maintain a healthy, vibrant economy, especially in a time of financial crisis. That is why it’s essential for individuals and businesses alike to ally themselves with a financial institution that is strong, committed to the markets they serve and has a proven track record of success during difficult times.
With that in mind, here are a few factors that you should look for when choosing a banking partner.
- What is the history of the bank?
- How long have they been around and how have they fared during similar periods of financial distress?
- How experienced is that bank’s executive team?
- Are they homegrown or transplants from another state? While either is acceptable, having homegrown talent may give the business owner a better sense of the bank’s commitment to supporting the local market.
- Other technical factors to consider would be the bank’s leverage and capital ratios.
- How do they compare to their peers and the regulatory minimums?
- Finally, individuals and business owners should take time to build a relationship with their bank and its bankers.
- The ability to call your banker and discuss challenges or opportunities can go a long way in assuring yourself that you have a solid financial partner during good and bad times.
For 30 years, The National Bank of Indianapolis has served its community by providing superior service and local decision making. The Bank has not only survived prior financial crises (2001, 2008, 2020) without government assistance, it has come out of those periods of time stronger and healthier by staying true to sound banking practices of maintaining a solid capital base, high credit standards and the pursuit of safe, steady and profitable growth.
A financial crisis can be scary for individuals and businesses to navigate. That is why it is crucial that you partner with a financial institution that is strong and committed to the communities it serves.
For individuals looking to establish a trustworthy banking relationship with an experienced professional, connect with our Personal Banking specialists.
For business owners who want a supportive partner with the experience to help through any financial storm, connect with our Commercial Banking team.