New technology bankers face old school banking lesson
The collapse of Silicon Valley Bank (SVB) can be explained as the consequence of rapid growth and poor risk management. In short, SVB grew its deposits by over 250% in 3 years. The nature of its deposits came from a very small number of clients, unlike most banks with a widespread number of savers.
Through 2020, when interest rates were low, Venture Capital firms raised significant monies. In the US, SVB was a bank that took these funds as deposits, which grew from $70bn in 2019 to around $200bn in the middle of 2022. Rapid growth.
SVB a case of poor risk management and aggressive growth.
These deposits were then used to buy US Treasuries. So far so normal, but the problem was that the bank bought longer dated securities. When interest rates rose in 2022 these bonds fell in value by around 20%; poor risk management, especially in a bank without a Chief Risk Officer since April 2022.
Towards the end of 2022, Venture Capital firms started to withdraw their deposits to fund their businesses. So the bank had to find capital to meet deposits without flagging up the reality that their bond portfolio was unable to meet the demand for cash, due to investment losses. As a result, it tried to raise equity capital last week to meet this demand.
So fast forward to last week. The Venture Capital world is quite small and once investors recognised a potential problem, the depositors requested their cash back from the bank.
This isn’t a re-run of ‘A Wonderful Life’ where queues of savers wanted to get into the bank to withdraw their cash, this was a bank run in the digital age. Instantaneous access is instant online, until it isn’t because the bank can’t meet its obligations.
So in an age of speed, the regulatory response has been impressive. By backstopping deposits, the US authorities appear to have curtailed contagion risk. A new age of deposit insurance has arrived in the US.
Hard Choice for the Federal Reserve?
The markets had spent much of the past few months reassessing the path of interest rates. At the turn of the year, investors had predicted that interest rates would rise in the first quarter, and then be falling through the second half of 2023.
As inflation is falling more slowly than previously predicted and the US economy is growing more quickly, expectations for falling interest rates had been priced out of the market up to events last Friday with SVB.
Over the weekend, investors have reverted to expecting an early peak in rates and cuts by the year end. In the view of some in the market the Federal Reserve has two options: 1) Hike interest rates and continue Quantitative Tightening to combat inflation or 2) Cut interest rates and add liquidity to secure the system, while inflation will run too hot. Rock and a hard place?
Policy can support financial stability whilst dampening down inflation pressure
We are not so sure. Just like in the UK after the Truss Budget in the Autumn, when the Bank of England moved to ensure financial stability but have since increased interest rates, the Federal Reserve may prove to be more multi-dimensional in their policy actions. We wait and see and will act accordingly.
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