Never ignore the bank’s vulnerability, even if the lender involved is not mainstream. The closure of Silicon Valley Bank (SVB) has already created contagion, wiping out tens of billions in the value of banks in New York and around the world.
The great financial crisis started with the collapse of broker Bear Stearns in the US and mortgage lender Northern Rock here in the UK.
The paradox of the current quake is that it can be traced back to the aggressive attempt by the Federal Reserve to beat inflation with aggressive rate hikes. Higher funding costs are considered a good thing for retail banks.
In the recent 2022 earnings season, the majority of High Street lenders increased their gross lending margin, which is the difference between what they pay savers and what they charge borrowers.
In almost every case, this produced “windfall profits,” allowing banks to bolster balance sheets, increase dividends, and pay unholy bonuses to bosses.
Vulnerability: The closure of Silicon Valley Bank has already created contagion, wiping out tens of billions worth of banks in New York and around the world
There is another side to the interest rate story, as we saw in the UK, when the Truss ‘idiot premium’ rocked markets in late 2022. Concerns about the UK’s untested mini-Budget led markets to dump sterling and government bonds.
The sharp fall in the value of gold-plated bonds has wreaked havoc on Liability-Driven Investments (LDIs), the derivatives at the heart of the pension system. Without the intervention of the Bank of England, insolvencies could have spread across the markets.
SVB is closely associated with US West Coast technology. During Covid-19, there was a speculative bubble with venture capitalists and other financial groups shifting money to entrepreneurs and start-ups.
So much money came in that the techies couldn’t spend it fast enough, and deposited the surplus with SVB—Silicon Valley’s banking darling. The bank invested much of this excess money in long-dated US government bonds, which, like UK government bonds, are considered the safest asset class. As market interest rates rose, the underlying value of the bonds plummeted.
Fixed rate instruments work like seesaws. When interest rates move, the value of the underlying bonds moves in the opposite direction. As market interest rates rose, corporate savers, such as the tech companies, expected better returns. While most NatWest or Barclays consumers left their savings where they were, companies are trying to maximize returns by moving cash deposits to locations with higher returns.
There was an effective run on deposits at SVB, so the bank tried to solve the problem by selling $21bn (£17.5bn) worth of long-term bonds. It replaced them with short-term but higher-yielding assets, leaving a large hole in its balance sheet.
The SVB model, as with Northern Rock in 2007, is an outlier. Northern Rock was the only lender to offer 110 percent mortgages and funded nearly all of its loans by converting long-term deposits into repackaged short-term securities. It seemed to be an exception, but, as we later learned, almost every British and American bank had its balance sheets stuffed with repackaged, high-yield securities based on rotten subprime mortgages.
The latest major sell-off of bank stocks on both sides of the Atlantic is not just a knee-jerk reaction. Bonds have the imprimatur of sovereign governments and, with the exception of serial defaulters such as Argentina, are considered solid.
Inevitably, since the financial crisis, regulators have required banks around the world to hold large amounts of bonds as a buffer of capital.
The rapid rise in US overall interest rates has rocked bond markets and left US banks with massive unrealized losses.
It won’t be a full-blown crisis unless big and small consumers get spooked and withdraw money, forcing banks to return their bond holdings at a loss.
SVB may have started with the defeat, but it is far from the only bank to have similar problems. As always with financial contagion, one never quite knows where it will end. Shares in London-listed Molten Fund, which has a stake in fintech outfit Revolut, capsized in the latest trading.
In the US, start-ups are warned not to hold more than $250,000 (£208,000) in cash in a single institution. It doesn’t feel like 2008, but anyone who lived through the latest banking disaster will recognize how quickly stability can unravel.
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