Regional Bank Crisis
Recently, two regional banks, Silicon Valley Bank (SVB) and Signature Bank have been caught up, to some degree, in the making of their own demise. Both were seized by regulators last quarter, as their depositors realized the banks were struggling to keep up with withdrawals and were being forced to sell securities at a loss, to keep up. Ultimately, regulators intervened, citing a lack of confidence in their respective management teams as they experienced a run on deposits. Below is a quick primer that led to SVB’s collapse:
- SVB worked with venture capitalists (VCs) and startups. Due to the pandemic boom, SVB saw a massive increase with deposits (300% increase).
- Banks lend out deposits at a higher rate than what they pay depositors – so SVB needed to do something with these deposits. Rates were very low, so they took some duration (maturity) risk and bought 10 to 30 year bonds. Much longer than many of their competitors.
- Rates increased faster than expected and SVB was exposed to this interest rate risk, resulting in significant losses from their bond portfolio. As this was occurring and the economy began to slow down those VCs and startups needed to withdraw more of their deposits to make payroll. Ultimately, SVB was running out of cash.
- SVB had to raise capital from investors or sell more bonds at a discount. They tried to raise capital, but once word got out about their financial position, VCs told their startups to pull their money, which led to a good old-fashioned bank run.
Yes, an increase in rates created havoc on bond holdings, which many banks maintain to help generate income over and above their interest liabilities on customer deposits. However, many banking institutions were able to hedge against this interest rate risk by owning shorter-duration assets, or adjustable rate assets, that are more resilient to interest rate shocks while also ensuring they didn’t over commit on their own liabilities. In addition, these other banks had more diversified customer profiles, meaning they were not over exposed to the slowing tech or Crypto sectors of the economy.
SVB and Signature didn’t manage this risk, as they should have. In part, effective lobbying in 2018 led to the raising of the stress test thresholds on regional banks from $50 billion to $250 billion, allowing SVB (whose CEO was pivotal in those lobbying efforts) to fly under the radar with a little over $200 billion in assets. Signature Bank’s issues aren’t as clean cut, and while also tied to mismanagement of assets vs. liabilities, had additional exposure to the Crypto ecosystem and its depositors.
Internationally, there have been concerns about Credit Suisse and a necessary intervention by Swiss regulators. To be sure, Credit Suisse has been having issues for a period of time now. Late last year, they shored up their capital base by taking in an investment from the Saudi National Bank. Last month, when the Saudis announced they would not be increasing their stake in the bank, the market reacted swiftly, in light of SVB and Signature Bank’s recent woes. It was terrible timing for Credit Suisse and its stock price experienced a significant sell-off. The Saudis claim that they didn’t want to boost their stake over their current 9.9% holding, because it would flip a switch on regulatory oversight. It’s not clear that is actually the case, but that is the claim.
The initial risk to the Swiss bank wasn’t as much about liquidity and depositors assets, as it was about the bank’s overall long-term profitability and business strategy. However, the “bank” is large and includes traditional commercial banking activities, investment banking activities and a wealth management unit. So, if their profits plunge, it calls into question their ability to make due on their interest and maturity payments to bond holders of the bank and cover all liabilities (which includes depositors). The Swiss bank claimed it had a healthy liquidity coverage ratio and can handle more than a month of heavy outflows in a period of stress, which is required by Swiss regulators. Nevertheless, the Swiss regulators and central bank intervened and brokered a sale of the bank to the UBS Group AG.
To be clear, these issues we are seeing in the banking sector are not the same as 2008. The financial system’s exposure to credit default swaps, collateralized debt obligations and other shaky financial assets are not the primary issues this time around. But, finance is an ecosystem, so cross exposure and depositor confidence is something everyone will be watching. The Treasury is actively reviewing the US banking system and exploring ways to ensure depositors’ assets are secure, while simultaneously seeking to understand if any other banks are experiencing similar financial strains.
Currently, we believe the actions of the regulators have been sufficiently swift and significant to help shore up confidence among depositors. However, the stress on regional banks is of concern and will have a broader impact on the economy in the form of higher interest rates and lower liquidity due to fewer loans being underwritten. Our concern is not so much about system-wide contagion when it comes to bank deposits or bank liquidity, but more about the economic slowdown caused by less money flowing through the economy, which could push us closer to a recession.
Long-term, we know we will get through this like we have with previous economic setbacks. Although, in the short-term, there is potential for liquidity shocks and more uncertainty in the banking system. However, given the recent banking reforms and the current attention being given to the balance sheets of these regional banks, we are confident that the impact will be limited and not lead to broader financial system instability.