By Krishna Jha
The world was shocked as the news came that two top American banks — both Silicon Valley Bank and Signature Bank —collapsed in a series. So far, the explanation has been that it was only traditional bank runs. It was also added that in an unexpected turn, depositors were there to withdraw their funds from the bank, all at once, and at the same time. The reality was that the collapse of SVB and Signature Bank was among the darkest events in US banking history since the great crash in 2008.
According to reports, in the phase of near-zero interest rates, SVB invested billions of dollars on US government bonds. It was considered to be a safe investment, but soon it was realised that to combat inflation, the Federal Reserve aggressively raised the interest rates. Here was the danger emerging in its full form as the SVB bond prices were soon on decline as the interest rates kept rising. The rise in rate started eating up into the value of SVB’s bond holdings. Reuters said that the portfolio was yielding an average of 1.79 per cent last week, well below the 10-year Treasury yield.
It was also the time when the Federal Reserve’s rate hikes resulted in the going up of the borrowing costs, forcing tech businesses to devote more funds to debt repayment. At the same time, they were having difficulty raising new venture capital money. Companies were forced to use SVB deposits to fund operations and growth, said the report.
While SVB’s issues may be traced back to prior investment mistakes, the bank’s run was precipitated on March 1, 2023 when the lender disclosed that it had sold a slew of securities at a loss and would sell 2.25 billion dollar in new shares to plug a hole in its finances. Horrified, the depositors started withdrawing huge money.
The bank’s stock fell to 60 per cent on March 2. The investors apprehended that a repetition of the global financial catastrophe that had taken place a decade and a half ago was at hand since there was a dragging down of bank shares.
According to available reports, trading in SVB shares had ceased by March 3. The bank was crumbling and was not able to raise funds or find a buyer. At this moment, California regulators took the charge, closing the bank and placing it in receivership under the Federal Deposit Insurance Corporation, which normally entails liquidating the bank’s assets to repay depositors and creditors.
Here comes the issue of liquidity. Liquidity is the risk when the bank loses all its strength to be able to meet its obligations without incurring losses.
Bank was helplessly watching customers withdrawing their deposits beyond what it could pay using its cash reserves, and so to help meet its obligations the bank decided to sell 21 billion dollar of its securities portfolio at a loss of 1.8 billion dollar. The decline caused by the drain on equity capital led the lender to try to raise over 2 billion dollar in new capital.
SVB’s customers were shocked at the call to raise equity and lost all confidence they had in the bank. They started withdrawing cash. In fact when the bank comes down to this stage, any functioning bank can go bankrupt, especially in these digital times.
In part this is because many of SVB’s customers had deposits well above the 250,000 dollar insured by the Federal Deposit Insurance Corp. It was not unknown to the depositors that the bank could fail and the deposits might not be safe. Roughly 88 per cent of SVB’s customers were uninsured, the report said.
The other bank, which was Signature, faced a similar problem, as SVB’s collapse prompted many of its customers to withdraw their deposits out of a similar concern over liquidity risk. About 90 percent of its deposits were uninsured.
According to a report from The Conversation, all banks face interest rate risk today on some of their holdings because of the Fed’s rate-hiking campaign. This has resulted in 620 billion dollar in unrealized losses on bank balance sheets as of December 2022. But most banks are unlikely to have significant liquidity risk.
While SVB and Signature were complying with regulatory requirements, the composition of their assets was not in line with industry averages. Signature had just over five percent of its assets in cash and SVB had seven per cent, compared with the industry average of 13 per cent. In addition, SVB’s 55 per cent of assets in fixed-income securities compares with the industry average of 24percent.
With over one trillion dollar of bank deposits currently uninsured, The Conversation report says that the end of crisis in banks are not to be resolved in near future.
Moody report says that the collapse of two private banks in the US might lead to the tightening of liquidity in debt markets globally as investors are getting wary. Meanwhile, there is no guarantee that the impact will be limited to only these two. The ripples may reach the world over, hence the caution. (IPA Service)
