The collapse of Silicon Valley bank (SVB) is the second biggest bank impending collapse in the United States and the news gave global investment analysts a topic for discussion, at least, over the next fortnight. Heralded as a trigger for another global economic recession, the SVB story is a duration management problem, which is typical in fixed income portfolios. On Friday, 10th march, 2023, the SVB, which is the banking haven for tech startups in the United States, collapsed within 48 hours. The hullaballoo around the collapse of the bank is justified considering that the bank is one of the biggest commercial banks in the United States with US$209 billion in total assets.
The SVB impending collapse originated when the U.S. Fed started hiking interest rate to slow the pace of inflation caused by excess liquidity from monetary and fiscal interventions during the pandemic. Parallel wise, due to the glut of liquidity from clients, the SVB was heavily invested in long-term fixed income instrument to match the duration need of clients. In fixed income portfolio management, a heavy position in long-term instruments is ideal when interest rates are expected to fall. However, interest rates spun in the reverse direction, leading to huge losses on SVB’s fixed income portfolios. Since the bank was heavily levered, the losses were amplified. If the U.S. Fed had turnaround the hike in interest rate, the collapse of SVB could have been averted. To complicate matters, it was difficult for SVB, like other commercial banks, to create fresh loans to borrowers due to the high interest rate. Furthermore, the interest rate hike pushed the risk premium higher, resulting in dwindling valuation for tech stocks, which are conventionally volatile, because of their unpredictable cash flows.
It is not so clear why other big banks are not touted as susceptible to collapse. However, a theoretical thesis is that SVB’s portfolio is unique. The bank has a preponderance of startup tech companies as clients, and a heavy allocation to long-dated fixed income instruments. The “panic effect” among SVB clients fostered the run-on on the bank.
Amidst widespread analysis, I am of the view that the collapse would not trigger a financial market crisis. Unlike the 2008 global financial crisis, which hinged on widespread default on mortgages among households, leading to a crash in the market for mortgage-backed securities, the collapse of SVB banks is on a macro scale. Institutional investors like hedge funds, and private equity firms are the most affected parties in this context. Furthermore, the banking system in the United States is more liquid and has more capital for depositors’ insurance. Hence, a ripple effect on a large scale is unlikely. At best, smaller banks, which are counterparties to SVB will be affected, but there will likely not be a major financial crisis.
The morale of the SVB story is that monetary policy, where a rate hike or policy accommodation, should have a timeout. The insistence of the Fed to maintain the rate hike is inimical to the survival of small banks, especially those with a high number of clients from volatile sectors. I believe that the pent-up inflation level is here to stay and the sooner the U.S. Fed realizes that they cannot use monetary policy to push inflation below the new inflation normal, the higher the chances of averting the collapse of another bank.
Written by Michael Ogunremi
Fascinating read. thanks for sharing and your commentary . My question what would cause the next one?