Over the past two weeks, bank stocks have taken a beating across the globe triggered by the bankruptcy of a couple of US banks, most notably Silicon Valley Bank (SVB). Plenty has been written and plenty more will be written over the coming weeks. But this piece from Marc Rubinstein, a former hedge fund manager, specialising in analysing banks in his blog, perhaps best sums up the issue. With almost four decades of falling interest rates, people seem to have forgotten the effect of interest rate risks on banks and have largely focused on credit risk and liquidity risk. The rise in interest rates over the past year or so, the sharpest in decades, is unravelling those risks once again. This was fuelled further by the deposit boom caused by excess savings during the pandemic and the ease of moving money in the digital age. Marc explains how:
“During the pandemic, banks took in record volumes of new deposits. Between the end of 2019 and the first quarter of 2022, deposits at US banks rose by $5.40 trillion. With loan demand weak, only around 15% of that volume was channelled towards loans; the rest was invested in securities portfolios”
…When banks purchase securities, they are forced to decide up-front whether they intend to hold them to maturity. The decision dictates whether the securities are designated as “held-to-maturity” (HTM) assets or as “available-for-sale” (AFS) assets. HTM assets are not marked to market: Banks can look on nonchalantly as bonds lose value…By contrast, AFS assets are marked-to-market—a purer designation but one that injects an element of volatility into a bank’s capital base.”
So when interest rates rise, prices of these securities (typically govt bonds or mortgage) fall, forcing the banks to book losses on their AFS portfolios, in turn adversely affecting their balance sheets. However they remain unaffected by the losses in the HTM book unless sold off as if held to maturity, the bank recovers the capital entirely. In SVB’s case the ‘notional’ losses on the HTM were more than the equity which isn’t a problem as long as they are ‘notional’. But this ‘notional’ losses would turn real if forced to sell to fund withdrawal of deposits.
“Prior to 2022, there had only been 10 quarters of deposit outflows in the US in the past fifty years; we’ve now seen four quarters of outflows. But the factors that led to Silicon Valley Bank gaining deposit share on the way up are instrumental in it losing share on the way down.
…We’ve never really had a bank run in the digital age. Northern Rock in the UK in 2007 predated mobile banking; it is remembered via images of depositors lining up (patiently) outside its suburban branches. In 2019, a false rumour on WhatsApp started a small run on Metro Bank, also in the UK, but it was localised and quickly resolved. Credit Suisse lost 37% of its deposits in a single quarter at the end of last year as concerns mounted about its financial position although, at least internationally, high net worth withdrawals would have had to have been phoned in rather than executed via an app.
…The issue, of course, is that it is quicker and more efficient to process a withdrawal online than via a branch. And although the image of a run may be different, it is no less visible. Yesterday, Twitter was alight with stories of venture capital firms instructing portfolio companies to move their funds out of Silicon Valley Bank. People posted screenshots of Silicon Valley Bank’s website struggling to keep up with user demand. Greg Becker, the bank’s CEO, was forced to hold a call with top venture capitalists. “I would ask everyone to stay calm and to support us just like we supported you during the challenging times,” he said.”
So what seemed like a diversified depositor base who were unlikely to act in unison turned out to be concentrated given the connected nature of startups and VC community. And the ease of withdrawal online only accentuated this. We are reminded that a bank doesn’t necessarily have to go down because of bad lending only. This is an inherent risk in the current fractional reserve banking system and will likely trigger plenty of debate and likely policy action in the coming weeks and months.
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