Systemic

In the scarce hours between the time I completed writing my column Friday and the piece seeing print Saturday morning, so many things happened.

That piece warned specifically about Silicon Valley Bank (SVB) in the US selling shares at a loss to improve its liquidity and the signals this could send out to the market. More generally, it warned about the pressures the banking system might be under because of the rapid increases in interest rates intended to fight inflation.

Before the column saw print, US regulators shut down SVB. It was a rare intraday shutdown made necessary by the inability of the bank to service withdrawals – a classic bank run. This is the second largest bank shutdown in US financial history.

In cases of bank failures, hours matter. Otherwise, the economic fallout will be wide ranging. By the time it was shut down, SVB was the 16th largest bank in the US.

The latest report states that the Federal Deposit Insurance Corporation (equivalent to our PDIC) had taken over and will strive to “operate” the bank by Monday. That is well and good, except that it turns out 97 percent of depositors in SVB have accounts in excess of the $250,000 covered by deposit insurance. Many companies, mainly tech businesses in the Silicon Valley area, will find their cash trapped in the bankrupted institution while Federal authorities frantically seek a buyer for the failed bank. The ripple effect will be wide.

When news of SVB’s difficulties seeped out, the stock exchange panicked. The banking industry was worst hit, understandably. More specifically, investors began dumping shares in smaller banks and migrating to the larger banks. This adds to the pressure on small banks.

SVB might hardly qualify as a “small” bank by Filipino standards. It holds about $209 billion in assets and employs about 8,500. Since it was founded in the early nineties, SVB has been a key player in financing tech start-ups in the California area.

There are elements to this failure that are unique to SVB – but also elements that are systemic.

Fighting inflation, the US Fed sharply raised interest rates from just 1.5 percent in 2017 to 4.75 percent by the end of 2022. This caught most banks holding low interest rates Treasuries and bonds. Marked to market, these Treasuries and bonds represent staggering losses to the banks that held them.

All the banks are invested in the same “cheap” Treasuries and bonds. In that sense, there is systemic risk in what happened to SVB. If investors continue selling down the stocks of smaller banks, the situation could be aggravated.

SVB was particularly vulnerable. One bank advisor supplied an analysis of SVB’s peculiar vulnerability.

SVB serviced the tech industry in the main. Its concentration in one business sector is a vulnerability by itself. Banks are supposed to disperse their lending activities to as wide a range of business activities as possible to disperse risks.

SVB’s tech industry clientele was a boon as well as a bane. Its fast-growing tech clients made more money than they could invest at the same rate. The bank’s deposit base ballooned rapidly from only $40 billion to $190 billion by 2021, outstripping demand for loans. The bank, to prevent the funds from lying idle, put them in Treasuries and bonds. By the start of 2022, and before the current round of interest rate increases, SVB’s bond investments had reached $130 billion.

For perspective, these bond holdings were a third larger than the Philippines’ gross international reserves. It is a third larger than our entire national budget for this year. And that is only one “small” bank’s bond investments.

Since shutting down SVB, the Fed has been careful to distinguish between rescuing depositors and bailing out shareholders of a failed bank. The line between the two activities often seems too thin to matter.

Recall that in the generalized financial crisis of September 2008, the central banks were criticized for rolling out billions in taxpayer money to rescue rich bank owners. During the frantic bailout of the banks, some financial institutions that failed were handing our fat bonuses and pay raises to their top executives. It was clear, however, that the central banks had to somehow contain the crisis or risk collapsing the global economy.

It is probably unavoidable that during crises, as everyone seems to be running around like headless chickens, some still turn out to be smarter than others.

The next few days will be critical. Banks everywhere are observing the fallout from the closure of SVB with bated breath.

The US Fed has been trying to talk down the significance of SVB’s failure by describing it as a “small” bank with a localized clientele. But that cannot dispel the fact that this “small” failure happens in the context of turbulence in the cryptocurrency market with the failure of a major trader based in the Bahamas.

Over the next few hours and days, the focus of suspense will be the reaction of stock investors. If they begin selling down banking stocks, there will be more trouble ahead. The more systemic features of SVB’s troubles will move to the forefront.

The bank advisor we quote is betting the Fed’s response will escalate into a full-scale bailout of SVB – no matter the moral hazards this might court. The need to calm the markets will be more urgent than enforcing accountability on banks that fail.

He concludes that SVB is not too small to fail.