Banking crisis: 5 pieces of financial jargon, explained

In March 2023, Silicon Valley Bank (SVB) in the United States collapsed suddenly.

The failure of the California-based lender marked the largest bank failure since the 2008 financial crisis and sent shockwaves across global financial markets. US regional banks came under particularly intense pressure as concern grew among customers and investors about the financial health of other institutions.

Here is some useful financial jargon that can help explain the crisis.

A bank run entails too many customers of a bank attempting to withdraw their money at the same time. This usually happens if customers believe their bank is about to fail.

A bank run can turn a fear of insolvency into the real thing since banks typically do not hold enough cash to cover all their clients’ deposits.

Bank runs have played a major role in financial crises. During the Great Depression, for instance, thousands of US banks failed in part due to bank runs. “Loss of confidence caused anxious depositors to create ‘runs’ on banks as they tried to withdraw their money before the banks collapsed,” a US government archive notes.

More recently, SVB's collapse was fueld by a bank run.

Financial contagion occurs when a failure in one institution ripples through a sector.

Contagion often occurs during periods of intense financial unrest and can happen at a regional, national and international level. Moreover, since economic markets are heavily interdependent today, financial contagion can pose a particularly significant threat.

The collapse of SVB sparked fears of contagion as concern grew among investors and customers about the stability of their banks. The anxiety was especially acute for smaller banks.

Credit risk is the risk that a borrower will default on their loan.

Banks attempt to lower their credit risk in many ways. Mitigation strategies include taking steps to ensure borrowers are trustworthy and that loans are structured in ways that limit potential losses.

Recent interest rate hikes, however, have made borrowing more expensive, which makes it harder for banks to finance themselves and reduces the value of their existing loans. The fallout from SVB’s collapse has increased credit risk around the world as investors feared further failures in corporate debt markets.

Hedging is a financial strategy that investors and banks use to limit financial risks.

Hedging entails balancing investments to make sure that potential losses are offset by gains elsewhere. A specific investment trade aimed at lowering risk is often referred to as a hedge.

Maintaining a diversified investment portfolio is also a form of hedging as it mitigates total potential losses if there is a downturn in a single economic sector.

A moral hazard in economics refers to a situation where a bank or investor has an incentive to increase financial risks because they are insulated somehow from the potential consequences of the risk.

Many economists maintain that moral hazards in financial markets increase the risk of harmful economic activity. On the other hand, maintaining incentives for limiting financial risk could help markets avoid excessive and reckless risk-taking, experts say.