We saw the collapse of two major banks in the US with Silicon Valley Bank in California and Signature Bank in New York failing. In Europe, Credit Suisse had to borrow up to $54 billion from the Swiss central bank. What happened and should we be worried that there will be another collapse of the banking system?
Before its collapse, SVB was the 16th largest bank in the US. So what happened to it that caused it to collapse completely?
As you can gather by its name, SVB was located in the centre of the tech universe in Silicon Valley. They were the bank of the tech start ups. And lots of tech companies kept their cash with them too. Banks don’t keep all cash on deposit and they invested a large amount of their money in long dated bonds. This was their big error. Interest rates in the US have been at zero for a long time, meaning if there is a movement, it is one way…up. Bonds have an inverse relationship with interest rates. When rates go up, bond prices go down. Afterall, why would you invest in a bond offering 3% interest when you can get 4% on deposit? SVB had invested in long term US bonds, so increase in interest rates have a compounding impact on the value of the bond over the remaining term (which could be 20 – 30 years).
With tech companies hit particularly hard by a downturn in the economy last year, they called on their large cash deposits for cashflow. This meant SVB had to sell their bonds at a loss. The run on the bank was triggered by them announcing that they were trying to raise $1.75 billion in capital to plug the hole created by selling bonds at a loss, spooking deposit holders. In the US, $250,000 of deposits is federally protected and SVB held $151.6 billion in uninsured deposits with just $20 billion in insured deposits. With that much money at risk, companies wanted their money out, causing the bank to fail.
The collapse of SVB triggered the collapse of Signature Bank a few days later. Like SVB, Signature Bank’s held huge amounts of uninsured deposits, with 90% of their deposit book uninsured. With the risk that they could lose most of their deposits, there was a run on Signature Bank, causing it to fail.
The problem with Signature was no one wanted to step in and buy them, being put off by their business model. Signature lended heavily to private equity firms, real estate developers and crypto currency. In other words, they were a risky bank that no one wanted.
The collapse of SVB was felt throughout the banking sector and was a reminder that banks held large bond portfolios. We saw the value of banking stocks fall around the world. Add to that, Credit Suisse has been hit with scandals over the last few years and is trying to regain investors confidence. Then the publication of its annual report was delayed after its auditors, PwC, identified “material weaknesses” in its financial reporting controls.
When its biggest shareholder, Saudi National Bank, was asked if they would be providing more capital, “the answer is absolutely not” which further frightened investors. SNB already own 10% of the bank and owning more would open them up to unwanted regulatory requirements. Credit Suisse are one of the 30 world banks deemed too big to fail and the Swiss central bank stepped in to provide them with the required liquidity. Since then, their share price has rebounded, although it has not fully recovered at the time of writing.
What we have seen here are banks with niche markets running into trouble. Their problems are specific to their bank and not the system as a whole, although the weakening of regulation in the US under Donald Trump certainly didn’t help. In Europe, the capitalisation requirements of banks is still very stringent after the financial crises, so EU banks should not be getting into trouble.
This is not a systemic issue with banks and I do not believe we will see another banking failure like we did in 2007-08. Although I wouldn’t be surprised to see another few specialist banks in the US fail before this all washes out.
20 March 2023