Introduction
There has been significant market volatility in recent days, with sentiment hit by the collapse in the US of Silicon Valley Bank (SVB) following the decision by regulators to shut down the bank on 10 March on concerns over its liquidity and solvency. SVB was the 16th largest bank in the US and it represents the second biggest banking failure in US history.
The collapse of SVB was followed by the subsequent closure of Signature Bank, the 29th largest US bank and another with a large exposure to the technology industry, and intense speculation on the financial strength of Credit Suisse, a more significant global institution.
While these events are unsettling, and have created significant volatility in global stock markets, this update explains why we do not currently think we are on the cusp of another 2007-2008 style financial crisis.
What happened at SVB?
SVB had invested a large amount of its deposits into government securities and more specifically, it had bought tens of billions of longer-dated Treasury and agency mortgage-backed securities.
Whilst this approach is common practice at most US banks, unlike other banks that have large exposures to retail deposits, SVB was predominantly exposed to businesses that were exposed to the risk of reduced funding from private equity and venture capital funds. As these companies saw their funding slow, they began to draw down on their deposits at SVB.
However, with SVB having placed much of its excess liquidity in longer-dated bonds without sufficiently offsetting interest rate risks, when it started to sell its bond holdings to meet the increased demand for deposit outflows, it incurred losses. This subsequently impacted on its regulatory capital base and after an attempt to raise additional capital failed, the collapse came quickly.
Regulatory intervention
In the US, authorities have acted quickly to guarantee all deposits at SVB.
The UK-arm of SVB has been acquired by HSBC for a symbolic £1, which sees one of the world’s biggest banks rescue a key lender for technology start-ups in Britain. The Bank of England, which had organised the sale to underpin confidence in the financial system, said that the wider banking system was safe.
Is there a risk to other banks?
It is possible, and some commentators say it is likely, that the same issues may occur at other specialised or smaller regional US lenders, as seen with the failure of Signature Bank. However, it is thought that it is unlikely that larger, traditional banks will suffer a similar fate. Both the larger regional banks and the globally systemically important US banks have far greater exposure to retail insured deposits, greater access to wholesale funding and come under much greater regulatory scrutiny than smaller US banks.
In the UK and Europe, most banks will also tend to have more diversified, stable and insured deposits than SVB, whilst their bond holdings are lower. Furthermore, European regulations regarding liquidity, interest rate risk-management and stress-testing is more robust than those applied to SVB.
Credit Suisse concerns
On Wednesday, there were renewed concerns over Credit Suisse, which has had its own issues/scandals in recent years that long pre-date the collapse of SVB. On Tuesday, Credit Suisse had disclosed “material weakness” in its account controls, but insisted its financial position was not a concern. However, the news that its biggest shareholder, Saudi National Bank, would not join in any fund raising as this would take its allocation above the 10% mark, which isn’t allowed for its own regulatory reasons, contributed to the sharp fall in Credit Suisse’s share price on 15 March. Furthermore, this negatively impacted the already fragile confidence in the banking sector, leading to renewed sharp falls in wider global stockmarkets.
It was also reported in the FT that Credit Suisse had asked the Swiss National Bank for a public show of support, as well as from Swiss regulator Finma. This was followed by a joint statement from the Swiss National Bank and Finma aimed at easing investors fear, in which it was stated that Credit Suisse “meets the capital and liquidity requirements imposed on systemically important banks”. In addition, they said the bank could access liquidity from the central bank if needed. Credit Suisse said it welcomed the statement of support and said on Thursday it would borrow up to $54 billion from the Swiss central bank to shore up liquidity and investor confidence.
Origen comment
The last few days have been reminiscent of the Global Financial Crisis in 2007-2008, but it is important to note the quick actions from authorities that are aimed at providing reassurance to depositors; while investors in banks may lose their money, those holding deposits should be safe.
One of the biggest differences between the current situation and 2007-2008 is that the underlying assets held by SVB – government backed bonds and high grade debt – is substantially different to the sub-prime mortgage debt that was floating around this system before. There is no suggestion at present of fraud or misappropriation; this has simply been a mismatch of timescales that the bank should probably have foreseen, which came at the same time as their relatively unique deposit base required their monies due to their own funding falling sharply. When Lehman Brothers collapsed in the financial crisis they were the fourth largest investment bank in the US; until last week, most people hadn’t heard of SVB.
There is always a risk of a self-fulfilling prophecy with bank failure, as their business is so reliant on trust; when depositors get nervous and withdraw their money, having a ‘run’ on a bank’s capital (as we saw in the past with Northern Rock for example) means they have to sell more long term assets to meet short term demands. As more and more banking is digital, the speed of which deposits can be withdrawn has significantly increased and so bank failure can take place at a greater pace.
There are undoubtedly still risks to banks and markets, particularly the banking sectors, who are likely to remain volatile in the near term, as seen with the concerns arising over Credit Suisse. However, it is important to note that banks are generally now much better capitalised as well as being under stricter regulations than they were prior to the Global Financial Crisis and as such, we do not believe at present there are similar contagion risks.
However, the rapid rise of interest rates as a counter to rising inflation is clearly causing some challenges in the financial sector. These issues may lead to a potential impact on the pace of interest rate rises, particularly in the US. Prior to the collapse of SVB, it was widely expected that the Federal Reserve would raise interest rates at their meeting next week, but markets are now suggesting that the central bank may be more reluctant to do so due to the recent turmoil. There may also be some reluctance by the European Central Bank to proceed with the previously stated 0.5% increase on 16 March, whilst the Bank of England may now be more reluctant to announce a further rise next week. Global central banks are likely to be weighing the recent turmoil versus some persistent core inflation data before deciding on their next actions, but with combatting high inflation the main target, may still decide to pursue further interest rate increases.
CA9254 Exp 03/24.
