Can SVB shockwaves cause ripple effect to other shores?
Team Veye | 05-Mar-2023
It was only a week earlier that Silicon Valley Bank (SVB), had featured in the annual ranking of Forbes America's Best Banks for the 5th straight year. Its sudden collapse later and getting close on Friday (March 10) by the California Department of Financial Protection and Innovation sent shockwaves around the world.
Being the largest US bank to fail since the 2008 financial crisis made it more pronounced in financial circles. What baffled me more was the unverified claim that SVB had Moody’s credit rating of A just 3 days before.
SVB used to be one of the most prominent lenders in the world of technology start-ups. The problem originated when the US Fed started raising interest rates aggressively to about 5% in a very short span. As the interest rates continued to move up, startups found it hard to raise funds from VC. And began pulling out the deposits they had with SVB.
Since In 2020 and 2021 SVB had seen a huge influx of deposits, it had invested this money in Mortgage Based Securities (MBS). Bond prices being inversely proportional to Interest rates, with an interest rate hike, the value of the bonds that SVB held started to fall.
At the same time, while the start-ups wanted to withdraw the deposits SVB finding itself short on capital started liquidating its Bond portfolio at a loss and sold $21B of the portfolio at about $1.8B Loss. Not finding this enough, the Bank said it would require Equity Capital to shore up capital requirements and proposed $ 1.25 billion of Equity Shares to be issued.
Together, selling bonds at a loss and hurrying in raising capital was a clear signal of an impending panic from the depositors which compelled the California Authorities to act. The fast turn of events led to the Federal Deposit Insurance Corporation (FDIC) getting appointed as its receiver.
The investments that SVB made are generally safe, and normally not a problem, as banks invest for the long term. However, with interest rates surging, things can change rapidly when they have to sell in an emergency. SVB's clients were largely start-ups and other tech-focused companies, which had been struggling for cash over the past year.
Whether this will have a contagion risk? As for Australia, a similar situation looks remote except for ruining market sentiment. Australian banks have more diversified funding sources and have a smaller portion invested in tradable securities.
The banks here are also subject to what is known as the interest rate risk in the banking book (IRRBB) tests. This effectively models losses on a shock 200-basis-point increase in interest rates and requires the banks to hold an adequate amount of capital.
Australia’s banks have also established additional capital buffers. As per APRA-determined liquidity coverage ratios, banks are required to hold a large pool of high-quality liquid assets to cover a run-on-the-bank scenario.
The SVB crisis has revealed that most of their deposits were greater than the $US250,000 ($380,000) limit in the US covered by federal government insurance. This imparts an important lesson to large savers here too. To spread their deposits around so that more of their money is covered by the Australian government guarantee.
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