In recent weeks, we have received news of crises threatening a number of banks. People wonder if this means a new banking crisis or if it is just a crisis affecting a few banks. After all, there is a big difference between the two. Is there cause for concern in the financial and investment markets or are these developments only isolated cases?
Silicon Valley Bank
After a sustained period of success, a major US bank ran into problems. Silicon Valley Bank (SVB), with more than USD 200 billion in assets, faced insurmountable challenges in its operations and fell into the hands of the authorities. The USA has not seen a problem of similar magnitude since the 2008 financial crisis.
Based in California, Silicon Valley Bank is the 16th largest bank in the United States. The bank was taken over by the Californian authorities and the FDIC (Federal Deposit Insurance Corporation) on Friday 10 March 2023. The guaranteed deposits were transferred to a new bank, whereas the actual banking operations will be put out to open tender following the regular procedure applied by the FDIC.
Of the total of USD 170 billion deposits held by the bank, only 10 per cent were guaranteed. In the United States, the FDIC guarantees deposits up to USD 250,000. In the early days of the crisis, the US authorities announced that all deposits in the bank were safe.
SVB's clientele included companies and funds active in the venture capital (VC) sector. The company itself advertised that its clients accounted for about half of all technology and life science companies engaged in the VC sector. After a long stretch of good years, the industry has been struggling lately. This is not, however, why the bank is in trouble.
The biggest problem for the bank was posed by the general rise in interest rates. At the beginning of 2022, the 10-year US federal rate was around 1.5 per cent, only to rise to 3.5 per cent by the end of the year. As we see, the increase is substantial. SVB held USD 120 billion in government bonds, asset-backed instruments and other similar securities. They have fallen in value to the extent that at the end of 2022, the unrealised and off-balance sheet losses on these securities reached over USD 15 billion, an amount equal to the company’s equity. The bank’s risk management system failed. For some unfathomable reason, the markets did not notice this until March, even though the situation was already apparent in the reports released in the autumn.
State of the US banking system
The US banking system is in better shape than it has been in more than 25 years. The banks’ average equity is approx. 9 per cent of total assets. Before the financial crisis, it was closer to 3 per cent for large banks. So, a lot of positive progress had been made.
The general rise in interest rates has made the banking system less stable. According to the FDIC, the US banking system harbours USD 620 billion in unrealised losses on securities. At the same time, the aggregate equity of the system is EUR 2,200 billion. Unrealised losses will only materialise when the bank carries out a securities transaction or merger or runs into trouble. Under normal circumstances, unrealised losses are not realised when the bank holds the securities until maturity and then recovers 100 per cent of their value. While these securities are virtually risk-free, their real market value varies in response to interest rates.
As a result of the crisis facing SVB, the banking sector may have to regroup, compelling the regulatory authorities to occupy centre stage. The ways of working and indicators will have to be reviewed, once again.
SVB was, however, a special case. SVB may soon be joined by other banks if the real estate and housing markets continue to falter. Many regional banks depend on these markets for their business. The US housing market peaked last summer. The rise in interest rates has caused housing prices to fall, especially in the most high-priced areas and on the west coast. So far, the decrease in prices has been moderate.
Rising interest rates wreak havoc
Overall interest rates had been falling for two decades. The markets trusted that the rates would remain low for a long time to come. However, the situation was reversed as a result of the energy war launched by Russia in the autumn of 2021 and the attack on Ukraine in February 2022. Inflation accelerated, especially in Europe, driven by rising energy prices.
In the United States, inflation stems from a strong economy, low unemployment and a post-Covid boom. The price of energy was an added boost. For some time now, the US Federal Reserve has been trying to slow down the economy and even succeeded in curtailing inflation.
The impacts of the overall rise in interest rates are visible across the board. The housing market is declining at the same time as the stock markets are falling and technology stocks have collapsed. At one point, the UK pension system was on the brink of crisis and now the problems of the Californian SVB have highlighted the potential balance sheet problems of banks.
In conclusion
Silicon Valley Bank made big mistakes in its own operations. Also, external factors contributed to the problems.
Europe is facing a crisis in the form of Credit Suisse Bank. Its problems culminated in a massive withdrawal of deposits during the past few weeks. Finally, the bank, propelled by the authorities and the central bank, was taken over by USB. However, it is interesting to note that this is more a crisis of a single bank than a general banking crisis.
Credit Suisse’s fate seems to have nothing to do with the problems facing US banks or the overall increase in interest rates.
The rising interest rates are having a widespread impact. Many operators were lulled into a false sense of security convinced that interest rates would stay low for a long time. This changed last year. Now it is hoped that the inflation rates will come down, and the interest rates with them. Failing that, there is a risk that the crises facing individual banks could escalate into an unpredictable banking crisis.
The writer is VER's CEO Timo Löyttyniemi.
