A bank – not a sports club
Anyone who reads the abbreviation “SV” with or without accompanying capital letters in this country automatically thinks of a sports club. Unfortunately – as some readers will have thought in the last few days – “SVB” mostly didn’t stand for a local club, but for “Silicon Valley Bank”, and unfortunately club boards should probably not take a role model in the management of this bank.
Until recently, the world looked different. At that time, SVB was considered by some investors to be the “gold standard” (https://www.handelsblatt.com/finanzen/banken-versicherungen/banken/gruenderszene-und-svb-so-arbeitet-die-tech-branche-den-kollaps-der-silicon-valley-bank-auf/29034494.html) on financing US start-ups. The reported figures were also presentable. On the homepage you can, for example, today (03/16/2023, call up the following figures:
Oops – a good 12 percent ROE doesn’t exactly sound like an impending catastrophe. Then what happened? Before we think about it, we should honestly admit that one has to be careful with banks and banks’ balance sheets. No commentator has or should have a deeper insight beyond published documents, otherwise one would have to ask him how he behaved as an insider of the listed bank during this time. So again: be careful! Notwithstanding this, one may certainly think as follows.
Some people with a more or less healthy skepticism about the new economy or start-ups will now say: “I always knew that! Dubious speculation and burning money. It had to happen that way!” If what has been reported so far is true, it is actually the other way around. Such start-ups collect money at the beginning, which they have to invest in the meantime in order to then have it available for additional funds in the phase when the money is initially burned. And what to do with the cash? Right: to the gold standard of start-up banks! Now, money is money when it comes from start-ups, so that shouldn’t be a problem after all. But it can be if what is presented in the media about SVB happens.
The (by no means new!) problem
The money that the start-ups and possibly other customers deposited with the SVB for the short term for the above reason was invested by the SVB in the long term in highly reputable US government bonds. The fact that the USA will not repay its debts is firstly not particularly likely – independence of the FED or not – and secondly, it is not the problem at all in this case. It’s just that
a) as a bank, you need money again if customers want their contractually entitled deposits back and
b) it has different effects on the value of money if its interest rate is fixed for different periods of time and there are interest rate changes on the capital market during the fixed period.
Let’s start with b), an earnings problem that most banks south of the North Pole have probably had recently, insofar as they primarily operate in the traditional deposit lending business. Longer commitment periods are usually associated with higher yields, which is why one also speaks of a normal interest rate structure (curve). As a result, as a bank you can achieve additional income in the long term, which is called “structural contribution” in German-speaking jargon. However, if interest rates on the capital market rise, you run into a problem, because the returns from your own investments remain constant, while you have to pay the increased interest on deposits for refinancing. Depending on how the interest rate structure changes, there are other effects, but that need not concern us here. It is important that the value of long-term interest-bearing securities then falls more sharply than short-term deposits and that the rise in interest rates on the capital market in 2022 was of almost historic proportions. It’s safe to speak of an interest rate geyser given the movement seen, as yields spurted up like hot water from Icelandic soil. How much you have to take this into account in accounting depends on which standard you are subject to. Even if you only have to process part of the effect through profit or loss in the annual financial statements, this is extremely unpleasant with an interest geyser.
If these figures become public, the already existing liquidity problem a) will be exacerbated again, because some people suddenly worry whether their money is safe and withdraw it even if they would otherwise not have wanted it, and new sources of refinancing would not are available to a sufficient extent. If more and more large deposits from the same sector that are largely not covered by the deposit insurance are affected and various parties recommend corresponding withdrawals, this can lead to a more or less ideal bank run. Well, the story at SVB is supposed to be something like that.
Where was the supervisor?
Obviously, the additional income described under b) cannot be earned without risk and for this reason or for other reasons it is often disrespectfully spoken of as “riding (on) the interest rate structure”. This is usually judged too harshly, because this strategy is quite justifiable in moderation and the maturity transformation is still seen as one of the tasks of the banking system: If the depositors want shorter commitments than the investment returns financed with the money allow, someone has to take the risks a ) and b), and it usually works well when the banks take on this task in interaction with each other and with the capital market.
If it doesn’t work, ultimately the gamble was too high, with the danger obviously increasing with the water column of the interest geyser. In order to prevent such problems, the banking supervisory authorities around the world make various specifications relating to interest rate (change) risk and monitor compliance with them.[1] If you hear something about “Basel” (with or without whole numbers) regulations, this is usually the starting point for corresponding specifications for the national legal systems. But why was it possible for the development to take place at SVB? Well, in the US, of course, there is also more or less effective banking supervision. However, only the systemically important and internationally active credit institutions are regulated there in accordance with the framework existing in the current version of Basel. If you are not such a “core bank”, other rules apply or “Basel” is not applied in full[2] and with a view to the SVB, it is to be expected that the maturity risk in terms of liquidity and income will be reflected rather inadequately.
If you are already regulating in a complex way, please do it correctly. After all, at SVB we’re talking about a bank with a balance sheet total of more than US$ 200 billion, and not about the change box of the famous chip shop around the corner. Otherwise, rough but much higher capital requirements are the better regulatory alternative.[3] This also applies with a view to the global shock waves that once again swept through the capital markets: however conditional toleration of important risks on the one hand and regulatory overkill on the other side of the Atlantic are certainly not a first-best Scenario.
Quantitative Easing im Pocket-Format
After previously having less control, the US banking regulator did not hesitate: When a planned capital increase by SVB failed, the bank was closed on March 10, 2023. Politics soon took the floor. US Treasury Secretary Janet Yellen herself declined to bail out the bank, but later joined US Federal Reserve Chair Jerome Powell and the US deposit insurance company, the FDIC, in declaring that all depositors will recover all their money above the US$250,000 per person federally insured amount.
All of this could only partially dampen the reactions on the capital markets. If you look at the actual commitment, however, there should be a little more optimism. If the problem really was only the maturity of the US government bonds, their takeover by a special purpose vehicle as part of the temporary bank closure is a kind of involuntary afterburner of the meanwhile ended quantitative easing, because the papers are now ending up in the public sector again. He is not exposed to the same liquidity pressure as the SVB and can sit out the matter until it is due. Even if he now buys the bonds more cheaply than in the last QE times, this will probably result in a sizeable economic loss, but that will certainly remain a much smaller evil than a further escalating bank run with uncontrolled consequences for the entire capital market. The ending was a logical decision, not a heroic feat or a stroke of genius, perhaps even too soft a landing for the overly careless SVB depositors. On this side of the Atlantic, two resolutions by smaller banks in the immediate vicinity were at best a side note.
And now?
What follows from all this for us? Most commentators appease and dismiss any comparison to the subprime crisis. This may tend to be the case and should calm many overly frightened minds a little. Perhaps the violent capital market reactions will soon be history.
Some investors are even hoping for a containment of the interest rate geyser in order to prevent SVB-analogous imbalances. In view of other aspects and data, that would certainly be wrong and so the ECB did well to carry out the announced key interest rate increase of 50 basis points on March 16, 2023. However, the assumed nexus also shows that we are still suffering from the unwinding of excessive interest rate dampening. The interest rate geyser was only able to reach such heights because the pressure under monetary policy had built up for far too long. If this knowledge is internalized by the responsible body, the SVB story might still have something good after all and German readers could relax and think of SV again in terms of “sports club” and not “Silicon Valley”!
[1] I also pointed out a partial aspect in Economic Freedom, cf.
[2] In an interesting article on the SVB, the ex-Bundesbank board member Andreas Dombret points out that the SVB was therefore not subject to the liquidity coverage ratio, cf.
[3] Which was propagated by prominent quarters especially after the Lehman crisis, cf. e.g. Admati/Helwig, The Bankers’ New Clothes, updated edition, Princeton University Press 2014.
Julius Maximilian University of Würzburg