The only cure for a crisis of confidence and anxiety is an improved understanding of the events that are occurring. We do not need to have a firm grasp of the complexities of every accounting rule on a bank’s balance sheet to make prudent decisions. This article tries to provide readers with a basic understanding of what happened in the banking sector (particularly with Silicon Valley Bank and Credit Suisse) recently. It is not exhaustive and technical details have been omitted for the sake of brevity and simplicity. Much like our own local soap opera with SSL, the events of the last few weeks are concerning but not new or surprising.
What Happened to SVB? - In English
- The failure of Silicon Valley Bank created unease among investors. There are several factors that are specific to this firm that exposed it to a higher probability of a crisis/ run. Let’s look at what they are:
- Concentrated deposit base: SVB had a very “concentrated” deposit base. In the case of SVB, the bank focused heavily on businesses financed by institutional investors such as private equity and venture capital funds. These clients tended to hold large balances in their accounts which were well above the US$250,000 limit which would be covered by the FDIC guarantee of deposits. This would have made them vulnerable to losing their money if the bank were to fail. The clients were also concentrated by industry. Many of these businesses were in the technology sector. As the sector began to feel the pain associated with higher interest rates (lower demand, lower valuations, less new funding), these companies needed to rely more and more on their deposits in the bank. Withdrawals accelerated due to the stress experienced in the technology industry.
- Too many long-term assets: Over 50% of SVB’s assets were invested in long-term US Treasury bonds. The irony is that US Treasury bonds are treated as the benchmark of safety across the globe. The problem was that as interest rates started to rise, the value of these securities declined, and they generated unrealized losses for SVB. When SVB went to liquidate these bonds to pay out depositors, the losses reduced the capital they had available. As a result, the company announced to shareholders that it was going to conduct a capital raise. This spooked investors and depositors. Thanks to the quick spread of information via Twitter and social media, within 24 hours of the announcement of the capital raise, SVB received over US$42 billion in withdrawals. All told, within 36 hours of the company’s announcement of a capital raise, the bank was being closed by regulators.
- Roll back in regulations: Placing so much of the investment portfolio in longer dated securities was a clear risk management mistake (among others). Some news reports suggested that the regulators had sounded alarms on SVB previously. It is worth noting that in 2018, the US rolled back some of the rules that applied to banks with asset bases less than US$250 billion. These banks had looser capital and liquidity requirements than their larger counterparts. This rollback facilitated SVB’s rapid growth in recent years. SVB’s total asset base grew from US$51 billion at the end of 2017 to US$211 billion at the end of 2022, a cumulative average growth rate of 32% per annum. The 5 years before the introduction of the regulation saw the company’s total asset base grow at a cumulative average growth rate of 22% per annum.
Why it is harder for this to happen at a bigger bank
Bigger banks must conform to more stringent liquidity and regulatory ratios. Many banks and financial institutions have internal limits on how much funding they can take from different types of depositors and usually have a wider and more well diversified deposit base. Additionally, many banks and financial institutions maintain internal limits on the percentage of their assets they can hold in long term securities.
But - What Happened to a big bank like Credit Suisse?
Credit Suisse had been fighting several years of scandals and bad risk management decisions that led to persistently large losses and expensive litigation. For a quick recap of what these scandals looked like: a criminal conviction for allowing money laundering in Bulgaria, a spying scandal involving a former employee, a fine for making a corrupt loan in Mozambique among others. Bad risk management decisions also resulted in massive losses that eroded capital. In 2022, Credit Suisse lost over US$6 billion, eroding the past 3 years of profit. In early March 2023, the U.S. SEC queried some of the reporting in Credit Suisse’s annual report, and it announced a review of the report. A public statement from the head of the Saudi National Bank, a major shareholder, that it would not consider increasing its ownership stake in the Bank further compounded the negative press. The spread of panic from SVB finally tipped the bank into crisis mode. The bank was acquired by UBS for US$3.3 billion in a Government brokered deal over a weekend. The Swiss Government pledged US$100 billion in liquidity to help UBS take on the operations of Credit Suisse. UBS will now be responsible for honouring any Credit Suisse debt or obligation (except for its AT1 capital notes).
Conclusion: The US bank failures and the Credit Suisse acquisition were triggered by a combination of firm specific factors, macro / market driven events and most of all, fear, and the loss of investor confidence. They are not indicative of widespread cracks or chronic issues in the global financial system. The head of the European Central Bank, Christine Lagarde, recently told EU Leaders that the Banking sector is strong. Both Janet Yellen and Jerome Powell have also made public pronouncements confirming the resilience of the U.S. banking system. In addition to the right amount of liquidity, capital and a diversified deposit base, financial institutions need confidence and trust – to withstand the ebbs and flows of the economic cycle.
Marian Ross is Vice President, Trading & Investment at Sterling Asset Management. Sterling provides financial advice and instruments in U.S. dollars and other hard currencies to the corporate, individual and institutional investor. Visit our website at www.sterling.com.jm
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