2023 got off to a better start than 2022 and was looking likely to correct some of the previous year’s losses. We have long said that markets tend to overshoot on the downside as well as the upside. It is the following sharp correction to the overshoot which catches market timers out.
Then came a bank run.
We doubt there is anyone alive that misses the days of 2007 and queues around the block to withdraw cash from Northern Rock. 15 years on, the major development seems to be that people no longer have to physically queue to start a bank run, but can do it from their mobile phones. In fact, there are increasingly fewer physcial branches to queue outside and so a traditional bank run might also involve a car ride these days.
Silicon Valley Bank UK held £7bn of cash for 3,000, mainly Tech, companies. The Bank of England has estimated that 95% of this was above the FSCS compensation limit of £85,000 and so would have been lost in the case of insolvency. Just as well then, that they managed to agree a last minute takeover by HSBC.
In very basic terms, banks take in deposits and then lend this same money back out again to borrowers. Regulators make sure that if a certain number of depositers want their money back, the bank has sufficient liquid reserves to pay them out. In practice it is much, much more complicated than that.
The parent, Silicon Valley Bank US, had tried to make more profit by investing the depositors’ short-term cash in long-term fixed-rate bonds. This can make money for the banks and therefore shareholders/senior executives if the returns you are giving to depositers are less than the returns you are receiving from investing their money. Unfortunately the US parent had run up losses of $15bn on these investments in Treasury Bonds due to rising interest rates.
It turns out that the problem with having Tech clients, is two-fold; they all know each other and they can communicate with each other instantly. Rumours of the Bond losses travelled around on WhatsApp very quickly and an extraordinary $43bn was withdrawn on the 9th March, causing the bank’s closure the following day (10th March).
With no parent as a back-up, SVB UK suffered withdrawals of £3bn on the 10th March, which used up all of their reserves in just 24hours.
Apart from the following collapse of Signature Bank in the US and the well publicised forced merger of Credit Suisse and UBS, there doesn’t seem to be any further contagion in the sector. Markets did not like these bank sector issues and started to look around to price in any other sectors that were at risk.
As we wrote last year about the UK’s Final Salary pension fund problems, there are other sectors that will become exposed in this new post-cheap money world. Property values are likely to come under pressure and we don’t tend to support property companies here in the West, in the same way that the Chinese government did with Evergrande. As debt gets more expensive, it narrows the marginal profits some are making and pushes others into negative territory. Any business that essentially borrows to invest is instantly exposed if assets are priced down and debt interest rises.
The Bank of England underestimated the leveraged position risk that the Final Salary pension trustees were taking (their own staff pension fund lost £1.5bn last year as a result of these positions). They have also probably underestimated the rest of the shadow banking sector and how its liabilities are inter-connected with more visible financial institutions.
Regulators alone are never going to fix all of the problems or prevent all of the risks in the financial sector. The culture needs to change from one of making quick and easy profits and risk taking, to one of working hard to provide useful services at a reasonable cost. In addition if we want cultural change, we need our Chief Risk Officers now more than ever.
It’s really hard to be a Chief Risk Officer in the shareholder value era.
Dr Kim Pernell, University of Toronto