What a difference a week makes. When news of the collapse of Silicon Valley Bank (SVB) first broke, most financial pundits were adamant that the bank was an isolated case, which should not be compared to the crisis in 2008.
There were good reasons for this view. SVB had a unique customer base which was heavily focused on tech start-ups and reported an unusual spike in deposits as a result of the tech boom during the pandemic.
Moreover, it had taken the bold step of not only storing the bulk of its cash in low-yielding US treasuries, but to also not hedge this investment against the risk of rate hikes. There was a case to be made that not many other banks had been that brazen in their risk management practices. Or had they?
After all, as most institutional investors are painfully aware, the practice of maturity transformation – of borrowing short and lending long – is at the heart of banking. And that appeared to be a risky business in a rising rate environment, as markets suddenly discovered.
Moreover, investors are acutely aware of the key lesson of the 2008 crisis, that banking us ultimately based on faith. In the event of a widespread bank run, any bank would struggle to meet redemptions.
Indeed, in the days following SVB’s collapse, bank stocks plummeted. At the time of writing, the FTSE is down more than 7%. The share price of HSBC, which bought the British arm of SVB, dropped by more than 20% within less than a week and other banks suffered too. While the US Federal Reserve stepped in to bail out SVB, Credit Suisse has found itself in the eye of the storm.
Credit Suisse: too big to fail
Investors recalled a series of unfortunate encounters the Swiss banking giant had with Archegos and Greensill Capital resulting in billions of losses. But the problems go far beyond an unfortunate association with tuna bonds in Mozambique.
Assets of the 167-year-old Swiss banking giant have dropped by almost 40% during the past two years. On top of this, the bank admitted to “material weaknesses” in its accounting standards and delayed the publication of its annual report, amid an adverse opinion from auditor PwC and concerns that it wasn’t meeting necessary liquidity criteria.
In Q4, customers withdrew CHF110bn (£98bn). Things weren’t helped by the fact that Saudi National Bank, a key investor in Credit Suisse, refused to up its stake. “Absolutely not” were the words of its chairman Ammar Al Khudairy, which caused credit default swaps for the Swiss lender to surge, pricing in a near 50% probability of default.
But Credit Suisse is a different level to Silicon Valley Bank. It has been listed as one of 30 systemically important banks by the Financial Stability Board, it is seen as “too big to fail”.
At the time of writing, the Swiss National Bank, which confusingly shares an acronym with the Saudi investor, has stepped in to hand Credit Suisse a $54bn (£44.8bn) liquidity lifeline. . Perhaps the £49bn in gold reserves that the Swiss central bank sits on might be enough to steer the tide in investor confidence. At the time of writing, this remains to be seen.
Dominoes
But the problems extend beyond Switzerland. Other banking giants, from Citi, Bank of America and European lenders, also saw their share prices drop. Investors fear that banks continue to be exposed to undue levels of duration risks amid rising interest rates. A scenario, that might be painfully familiar to UK defined benefit funds, which found themselves in the storm of last year’s LDI crisis.
Indeed, the potential for losses could be much higher than anticipated, according to a paper published in March by various academics, including Erica Xuewei Jiang from the University of Southern California and Gregor Matvos from Northwestern University.
The authors warn that the US banking system’s market value of assets is $2trn (£1.6trn) lower than suggested by their book value. They add that SVB was by no means the worst capitalised bank, and that 10% of banks in the US have greater unrecognised losses and a lower capitalisation than the tech-lender.
Investor headache
The scope of the potential problems might cause a dual headache for UK investors, according to Shalin Bhagwan, head of pensions advisory at DWS. “UK pension funds and their advisers will have spent the last few days trawling through their investments to ascertain the extent of their exposure to SVB.
“There would be a number of levels to this. Firstly, any direct exposure by their asset managers who may have been using SVB either directly or indirectly. Indirect exposures may occur through funds invested in listed and private markets. That said, Fed actions over the weekend should mitigate the risk of losses. However, prudent risk management may suggest that many funds may choose to revisit their banking arrangements through which, say, fund distributions and capital calls are directed,” he added.
But there is another element to the crisis: that of duration risk within institutional portfolios. Many investors have responded to the crisis by throwing their assets into shorter-dated treasuries, ironically the same assets that tripped SVB over. Yields on two-year US treasuries saw their steepest fall since 1987.
This marks a collective gamble that central banks will pause their rate hikes amid the risk of a full blown banking crisis. But the Fed’s chair doesn’t just have the collapse of banks to navigate, the latest inflation figures remain higher than anticipated.
Could this spiral into a broader crisis?
The jury is out, according to Bhagwan. “History will be the ultimate judge but it seems that SVB will sit alongside LDI. Both are poster children of the fallout from a rising rates environment where liquidity buffers ultimately proved to be inadequate. What is the lesson? Too many to mention.
“This episode is another painful reminder that borrowing short and simultaneously lending long requires sophisticated systems, proper governance and, perhaps most of all, humility,” he said.
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