Schrödinger's Box Encloses Global Banking Now.

Investors need to have faith in the system, however, their assurance is faltering and it's possible that more negativity may arise.

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The author is a contributing editor to the Financial Times.

The popular thought experiment in quantum mechanics suggests that if a cat is kept inside a box containing a fatal substance, its status of being alive or dead can only be determined upon opening the box. Until then, the cat exists in two states simultaneously. The current situation with banking poses a similar dilemma: we cannot confirm if the recent week's events were just isolated problems that can be contained or whether it marks the beginning of another banking crisis like the one in 2008. As of now, it is happening concurrently in both ways.

People who invest money and deposit funds in banks need to have faith in the banks' strong capital ratios, sufficient access to funds, and responsible behavior. They also need to trust that the supervisory and regulatory systems put in place after the financial crisis in 2008 are effective in ensuring the stability of the banking system. Although confidence levels may vary in the short term, ultimately investors must either have complete trust in all of these factors, or have no trust at all. The outcome is binary - either everything is working properly, or it is not. It's like a cat - it can't be partly alive and partly dead.

The recent instability in the banking industry seems to have arisen mainly from issues related to supervision and management. Specifically, Silicon Valley Bank, Silvergate Bank and Signature Bank had a higher exposure to interest rate risk due to their clients and assets, including long-term bonds that had to be sold at a significant loss to pay for deposits. Additionally, First Republic, which caters to wealthy depositors who may not be fully insured, is also facing concerns about its liquidity. Credit Suisse, which has faced numerous problems in the past, is currently dealing with a lack of confidence and issues related to liquidity. Overall, these issues are seen as treatable and should not cause major harm to the banking industry as a whole.

Thankfully, things have improved significantly since 2008. Banks are in a much stronger financial position now and are being regulated more effectively compared to their condition during the worldwide financial crisis. Despite the difficulties faced during that time, we have gained valuable insights and knowledge, including the significance of taking prompt and resolute measures to control the spread of problems.

The central banks took swift action to combat the liquidity crisis by implementing measures from their emergency response plans and acting as the final source of lending. SVB and Signature Bank were able to receive deposit guarantees from the US Federal Reserve, Treasury, and FDIC, and the Fed established a fresh lending initiative called the Bank Term Funding Program, which allowed banks with troubled securities to access funding at face value. Credit Suisse was also offered a credit line of up to SFr50bn ($54bn) from the Swiss National Bank.

The banking system is losing fundamental trust and Central banks and regulators need to act quickly to restore confidence. My concern is that there may be even more disastrous surprises lurking in the shadows. Small banks in the US have a significant proportion of their loans tied up in commercial real estate, about 28% compared to only 8% for the larger banks. Unfortunately, with the current high interest rates and the shift to remote working because of the pandemic, some of these loans are underwater. This means that if even just a few small banks were to experience significant asset write-downs, the ripple effect could lead to questions being raised over their solvency.

There is another danger lurking in the private markets. They are not required to update the value of their assets to reflect the current market conditions. This means that, unlike the public markets which have registered significant losses over the last year, private markets have reported much smaller losses on paper. To avoid taking a hit, private investors may hold onto their assets, waiting for their values to rise again. This delay tactic could backfire, resulting in staggering losses if the assets continue to plummet. A financial collapse could be caused by the instability instigated by the private markets.

It's important to avoid jumping to conclusions about the current state of the economy, but it's likely that we'll experience some economic turbulence as central banks withdraw their support by increasing interest rates and reducing their assets. We've faced banking challenges twice before - during the financial crisis and the eurozone crisis - and we need to take steps to restore trust in our financial systems. Even if things aren't as dire as they appear, we can't rely on luck to keep us afloat indefinitely.