Financial Instability is the cause of Global Economic Failure

As the global environment continues to evolve, leaders must stay informed of geopolitical changes to stay ahead. Proactivity is critical to success – but how? This article looks at the current splintering international order and examines what measures should be taken to remain resilient.

CEOs must pay close attention to geopolitical risks, as they can significantly affect financial performance. However, to stay ahead of the curve, it is essential for leaders to be aware of the latest global developments and anticipate any potential changes that could affect their operations. Additionally, CEOs must be proactive in assessing the impact of geopolitical factors on their businesses and be equally prepared to act decisively if needed. Doing so can protect their assets from potential losses and ensure their company’s long-term success.

As economic times become arduous and the U.S. Federal Reserve’s fund rate stays elevated, Chairman Powell has acknowledged that some economic hardship will be necessary to curb inflation. The Fed believed back in September that their outlook of a soft landing with moderate growth was achievable, expecting only minor rises in unemployment above their target level. Despite this, signs of recession have become evident, and the situation has worsened considerably.

The Fed is still determined to fight inflation, even if it leads to serious economic consequences. Nonetheless, the fed places considerable emphasis on the backward indicators of the jobs market and unemployment statistics. Economists anticipate that a return to neutral interest rates may not occur until 2024. However, the Fed will likely have to pivot much sooner as businesses seek liquidity to sure up their reserves for a period of slower economic activity.

Access to capital has become more stringent, making it difficult for small to medium-sized businesses to stay afloat in difficult times. This liquidity (or lack thereof) choke point has contributed to numerous company failures, resulting in debt defaults that affect supply chains and cause the unemployment rate to surge. Additionally, the signs of financial distress are also increasing at the consumer level. For example, the Finder survey (taken before recent hikes) revealed that more than one in eight Australian homeowners have failed to make a mortgage payment within the past six months. This data indicates a more significant issue that will only worsen if capital access does not become more fluid and frictionless.

The demise of Silicon Valley Bank has left a permanent mark on history, coming in second only to the largest U.S. institutions when it comes to assets lost due to failure. Anxieties over liquidity and solvency among banks have been exacerbated by depositors’ fear-induced bank runs, a contagion that could send shockwaves through global markets. Bank runs such as this, spurred on by depositor anxiety and fear of liquidity and solvency, have only added to financial stress and emotional distress.

Investment firms are quickly mobilising funds for their portfolio companies during this economically tumultuous weekend – preparedness necessitating an understanding that cash flow can make or break any business’s future success. However, bank failure becomes a worrisome reality for savers when economic security is questionable. Insolvency caused by insufficient funds to cover customer deposits and debts can trigger the demise of an institution – with peace of mind sometimes restored courtesy of government insurance guaranteeing returns up to an insured limit when it does occur. Nevertheless, not all banks are ‘too big to fail,’ and governments worldwide do not have enough in their coffers to support the decline of the banking sector. The only response for governments would be to raise the debt ceiling further, which would cause hyperinflation.

If a bank does fail, there is still some light at the end of the tunnel if not situated within a corrupt economy like Zimbabwe or some similar nations. Any financial institution with FDIC insurance ensures that deposits of up to $250,000 are protected against failure. Nevertheless, if deposits exceed the secured threshold at a bank which is then acquired by another entity after liquidation, organisations can still file an official claim for any additional assets left over. However, preparing for the worst is better than hoping for the best! While it may require jumping through some extra hoops and paperwork, there is potential to recover far beyond insured limits.

Fractional reserve banking is a system used by most economies today – allowing banks only to hold a fraction of their deposits and free up capital for economic growth. Although it has the potential to influence economic activity positively, there is also a significant risk that banks may invest in areas of the market that do not generate positive returns.

Even before gold and silver coins were commonplace, financial innovators found a way to leverage wealth and capital gains. By issuing promissory notes against accumulated precious metals deposits, savvy entrepreneurs created what we now know as fractional reserve banking – allowing them to collect interest on loaned money not held by their coffers.

Banks must rapidly advance their capabilities to strategically plan for fluctuations and challenges in the market by designing sophisticated models that assess risk across multiple departments and activities. Reverse-stress testing can efficiently demonstrate how an organisation could be impacted under immense pressure, allowing banks a more comprehensive picture of correlated risks throughout operations.

Banks are required to create, access, and routinely rehearse strategies for managing a liquidity crisis. Taking the time now to find suitable solutions is essential to ensure financial stability; the alternative is that ‘runs on banks’ will continue to arise.

Choke points always create inefficiencies which magnify into failures! SVB experienced a notable failure due to their inability to efficiently transform assets into cash to fulfil its obligations during a period of market pressure. Cryptocurrency companies can fall victim to the same issue when there are not enough outlets to convert tokens into fiat currency and vice versa. The root cause of the problem in the case of SVB was the bank’s inability to quickly and efficiently increase financing or other methods of procuring liquid assets. Although they had enough liquidity, they were unable to act in time, leading to fire sales and considerable losses, which demonstrates how critical it is to move swiftly when market volatility occurs.

Businesses must be aware of the effects that their practices may have, and they should aim to become knowledgeable concerning the laws, standards, and regulations that are in place now, especially those that cross international lines. Organisations need to maintain a reputable level of expertise to effectively manage their ventures within unfamiliar environments and ensure that their finances are secure domestically.

• CEOs should take away from this article the importance of assessing and anticipating potential geopolitical risks in order to protect their company’s financial performance.
• To do so effectively, leaders must stay current on global developments and be proactive in assessing the impact of geopolitical factors on their businesses.
• Additionally, they must be prepared to act quickly and decisively if needed, as swift action can help mitigate potential losses and ensure their company’s long-term success.
• In order to properly assess and calculate risk appropriately, CEOs should be aware of several key factors. First, understanding fractional reserve banking allows them to gauge better a bank’s ability to generate capital and access liquidity when investing.
• Banking regulations such as FDIC insurance protect against failure by ensuring deposits are secured up to $250,000.
• Further, additional stress testing across banking sectors can reveal any weaknesses or choke points that may arise during market volatility.

Finally, CEOs should familiarise themselves with laws, standards, and regulations across international lines in order to manage their ventures responsibly abroad. By remaining informed on these topics and being proactive with risk assessment strategies, CEOs can prepare for any sudden changes that could affect their operations and safeguard their assets from potential losses.

Strategy Hubb & OceanBlocks are the go-to consultants for tackling today’s toughest challenges and seizing tomorrow’s most significant opportunities. We provide accuracy through insightful analysis of business strategy, helping our clients achieve total transformation – from an increase in a competitive advantage to driving bottom-line results. Our experienced teams worldwide have a unique blend of digital technology, ESG consulting, and design expertise to deliver solutions that spark change within any organisation.

Disclaimer: Please note that the information provided in this article is not to be considered as financial advice. Please seek advice for your personal or business matters from a qualified professional or make contact with myself or one of the team at Strategy Hubb to tailor custom solutions to accommodate your circumstances.