By Tom Alford, Deputy Editor, TMI
Almost immediately following the dramatic collapse on Friday 10th March of two US lenders – Silicon Valley Bank (SVB) and New York’s Signature Bank – bank shares around the world started taking a serious hit. The US president Joe Biden had been forced to step in to reassure investors, businesses and the public that America’s financial system is safe and sound and that he would deliver “whatever is needed” to keep it that way.
So what went wrong? In this case, it was mostly interest rate rises finding gaping holes in funding that left it almost insolvent. It was caused by over-exposure to long-term (mostly US government) bonds and the unhedged bet that interest rates would stay low.
The debt markets had got used to borrowing for next to nothing. When rates started rising, and some major repricing in the global fixed income market was necessary, SVB’s customers started struggling to raise money through private fundraising or share sales.
Deputy Editor, TMI
With more of them withdrawing deposits it soon became clear that the bank itself could not raise sufficient money to bridge the gap created by losses from the desperate sale of those long-term assets. As the word spread about what was happening to SVB, customers dashed to withdraw their cash. It was a classic run that marked the biggest failure of a US bank since the financial crisis of 2008.
Around the same time, Signature Bank in New York, an FI with huge client interests in crypto, also had its assets seized by the Federal Deposit Insurance Corporation for much the same reason. It was reported that a number of other, smaller, US banks were looking at big losses to their share values, even though they claimed to have sufficient liquidity to weather the rising storm.
But fear spreads quickly, and with widespread banking volatility now seemingly back on the agenda for many – and it is a problem largely of perception in most cases – speculation is ongoing that the US Federal Reserve (Fed) and perhaps the Bank of England (BoE) may even halt further planned interest rate rises (reversals are highly unlikely at this stage). The European Central Bank (ECB), given to repeated recent 50bps hikes, may need to rethink its planned trajectory too.
With banks such as SVB finding it hard to manage the impact of rate rises – an unintended consequence if ever there was one – the likes of the Fed, BoE and the ECB may indeed seek to take a rate breather to avoid the contagion of fear. But then will taking quick and strong action, as the US, UK and other governments have seemingly done, be enough to stop irrational behaviour and hair-trigger market participants causing wider financial instability? Time will tell, but such action has recent precedent.
Back in September 2022, the UK pension sector was being battered by sharply rising long-maturity gilt yields. Many of these funds had been seeking missing bond yields through ‘liability-driven investments’, a form of leveraged derivatives strategy. As interest rates rose, so margin calls created a stampede to sell these LDIs, and technical insolvency loomed for many funds. The UK Treasury stepped in, extending a £65bn credit line to BoE so it could become the buyer-of-last resort. ‘Only’ £19bn was eventually required to resume order and by January 2023 BoE had even reportedly made a £3.8bn profit. The point is that intervention does work. And people have short memories when it comes to the markets.
Following the SVB and Signature collapses, the Fed announced a new lending facility that would be available to more banks as a way of ensuring their depositors’ withdrawal requests could be met.
News that the US government was protecting SVB and Signature Bank deposits in full – as part of a “systemic risk” exception process – was met with criticism that it was only encouraging future bank profligacy and risk-taking. But then the consequences of inaction were perhaps seen as even worse. And President Biden was quick to underline the fact that a promise of support for SVB customers would not cost taxpayers anything, as funding would come from the fees banks pay to regulators.
This is not the same as the 2008 crisis. Lehman’s collapse was a liquidity issue precipitated by some extremely risky activities that had spread far and wide. Regulators tackled the issues with a raft of regulations, not least around capital adequacy. The current events are about the liquidity and credit risk management of smaller and mid-sized banks.
Banks such as SVB and Signature Bank have a very tight focus on a particular sector – tech and crypto respectively. They were also clearly over-exposed to assets which, when interest rates started rising, saw their values coming under unbearable pressure, hence the losses and ensuing panic. Rates had been rising for some time, so should they have seen it coming and taken action earlier?
Changes since 2008 have forced most institutions to grapple with risk, become more diversified, and much better capitalised and regulated. It’s possible that increasing diversification movements will be on the cards over the coming weeks, not least as a measure to calm investors. Although by the Tuesday after the Friday before, US banking stocks had started making a solid recovery in early trade on Wall Street. FTSE 100 trading that afternoon was enjoying the warming tailwinds from Wall Street.
For now though, the banking sector and its customers are paying the price for the mistakes of a few. If interest rates do continue to rise, it may yet uncover what one commentator referred to as “more ticking time bombs”.
While some confidence has been restored by regulatory action, in the short term, treasurers will naturally be asking if they have sufficient risk mitigation in place. This may include looking at banking limits and exposure policies, and diversification of investments. Many too will be looking deeper into their stress-testing and scenario analysis capabilities to see if they are getting a handle on such events.
In the longer term, with the chair of the Fed, Jerome Powell, already stating that there will be a thorough and transparent review of the collapse, the work rests with the banking community. It should expect the regulators to come knocking with a whole new set of questions and, eventually, regulations. Of course, for many treasurers, having yet more to deal with is a less than desirable outcome.