What’s going on with the banks right now?
Mar. 22, 2023
March saw a crisis in the banking industry that began with the collapse of two American lenders, Silicon Valley Bank and Signature Bank, and then the Swiss giant, Credit Suisse. SHoF director, Bo Becker, explains what triggered the crisis and if European and Swedish banks are at risk.
This article was published on March 23 2023.
What happened at Silicon Valley Bank?
Silicon Valley Bank (SVB) grew a lot in the last few years as much of venture capital fundraising ended up as deposits. This was peculiar for a few reasons, most importantly because it made SVB very exposed to a single industry, and because the deposits were large, meaning in excess of the $250,000 deposit insurance limit. When rates went up in 2022 and venture capitalist flows dried up, the growth of deposits ceased.
Meanwhile, the deposit inflows were such that SVB did not have lending opportunities. They invested in securities, and mostly treasury securities and mortgage-backed securities (MBS). All this is low credit risk – the future cash flows are safe – but had very high interest rate exposure – because the bonds had long maturity, they lose a lot of value when rates rise. Apparently the average duration of the mark-to-market bonds of SVB was 6 years, indicating very high sensitivity to interest rate changes.
Small deposit outflows forced SVB to realize losses on the securities. This raised more questions about the bank, creating pressure on the share price, and then Friday morning (March 10), depositors tried to withdraw $42 billion. This was a quarter of SVB’s deposits, and veryfew banks could manage that kind of balance sheet shrinkage in a day.
SVB was taken over by the regulator (the Federal Deposit Insurance Corporation, or FDIC), which guaranteed all deposits (including the big ones), and which is now selling the assets of SVB while a ‘bridge bank’ serves depositors.
Shouldn’t SVB have hedged the interest rate risk?
Short answer: yes. Apparently, SVB lacked a chief risk officer for most of 2022. According to the Financial Times, SVB hired Blackrock to assess their fixed income risk and discovered that Blackrock had cautioned SVB about their risk controls being significantly lower than those of their peers, as early as January 2022. SVB received a “gentleman’s C rating— not a good grade. Despite Blackrock's offer to assist in strengthening risk controls, SVB declined.
Furthermore, SVB used to hedge rate risk with swaps but stopped. The swaps they had were unwound in 2022. According to their 2022 Q2 financial reports, they were then “shifting focus to managing downrate sensitivity”. So, it looks like they wanted a huge one-way bet.
Are European and Swedish banks at risk?
Very few banks in the U.S. or anywhere else have the combination of high interest exposure in securities portfolio and uninsured deposits. So that particular scenario is unlikely.
For Swedish banks, interest rates could squeeze profits if they have funded fixed rate mortgages with deposits (which are getting more expensive). But much of the mortgages are funded with covered bonds with fixed coupons, or are hedged with swaps.
That said, rising rates cause losses of market value in (long maturity) fixed income portfolios. Insurance companies, central banks, and pensions funds are sitting on large losses. Most of the time the situation is fine as long as this is not in banks - no one will run on a pension fund. In addition, right now, given the bank stress, interest rates are falling, and inflationary pressures are easing up. So currently, interest rate-related pressures are easing.
Did regulators mess up?
The stress tests run by banks at the best of the Federal Reserve included higher rates, but not as high as they actually went in 2022. Mistake? Maybe— did you know rates would hit rise above 4% last Fall? I was concerned about inflation but did not make that prediction. Still, it was probably a shame that no regulator asked about the swaps that were being dropped. Mistake or poorly designed regulation. I predict reforms are coming for mid-sized banks.
What about Credit Suisse?
Credit Suisse is (was) a huge bank, with much more complex operations than SVB. They have had profitability problems for years. If rates played a role, it was more that the ultra-low rate environment helped them survive for years despite structural challenges with the business. There may be a few more financial institutions that have similarly stayed alive thanks to low rates but with underlying business model weaknesses