Since the beginning of March, a few incidents happened in the banking sector. This came quite unexpectedly at a time when everybody was saying that the banking sector is nowadays much more resilient than in the past. What went on and could this mean a new crisis like 2008?
It all started with Silvergate in the US. Silvergate’s core business was the provision of banking services to cryptocurrency platforms such as Coinbase and FTX. Then came the FTX scandal and many customers closed their accounts in the crypto platforms, fearing a contagion.
Many of these accounts were deposited with Silvergate. In order to meet the fund requests, the bank had to liquidate the securities portfolio that was composed in large part of long duration bonds whose value had fallen due to the increase in interest rates. Sales caused a loss of about $880 million. These losses led to the closure of the bank and its liquidation.
After Silvergate it was the turn of Silicon Valley Bank, which was the bank of technology start-ups. The explosion of funding by venture capital companies in 2020 and 2021 had flooded these cash companies that were held in deposits, often with SVB. In 2022, however, there was a reduction in venture capital funding and IPOs. These start-ups, which typically burn cash, began to consume their deposits at SVB.
As in the case of Silvergate, in the face of the reduction in deposits, SVB had to liquidate the long-term securities portfolio, incurring losses of 1.8 billion dollars. There was a desperate attempt to increase capital and sell the bank, but neither option went through. This prompted the regulator to order the cessation of business.
The panic spread to other US regional banks with deposits flowing to bigger banks and another bank, Signature Bank, was closed as well.
Then it was the turn of Europe with the Credit Suisse drama. The Swiss bank, once a solid and very well respected giant in asset management and investment banking, in the last years run into a lot of problems and scandals that at the end damaged its reputation and caused an adverse impact on the business and financial results.
At the end the situation become unbearable and the bank went through a sort of forced sale to UBS in which the Swiss government and the Swiss Financial Markets Supervisory authority also played an important role providing a 100 bn francs line of liquidity and accepting to bear some of the losses that could arise from Credit Suisse assets.
When do banks run into trouble?
Let’s start by asking ourselves, how can a bank fail.
Basically, there are two kinds of issues a bank can run into.
- The first kind of issues is when a bank is unable to deal with customer withdrawal requests or the request to transfer deposits to other commercial banks. This is called a liquidity crisis. The extreme case of liquidity crisis is that of «bank runs».
- The second kind of problems has to do with the fact that banks could not have enough capital to cope with unexpected losses on its assets. This is called solvency crisis. If the value of the asset of the bank is reduced (for example, because of a loss on a loan disbursed that is not repaid), a similar reduction must occur in the bank’s capital. If the capital is completely consumed by the loss and the liabilities become greater than the assets, the bank is technically insolvent.
What is going on now
The issues that we are seeing now mainly takes the form of a liquidity crisis. For some reason there is a flight of deposit to which the banks cannot cope because this would involve selling assets at a loss.
We have to say that these assets are quite healthy. Their value was just reduced by the increase in interest rates, but their creditworthiness is sound. In many cases, they are US government bonds. That is why the FED has put in place a facility in which it offers loans accepting bonds as a guarantee valued at 100 even if their market value is currently lower because of interest rates increase.
This is very different from 2008 when the credit quality of bank assets were very poor, and they incurred in huge losses due to dodgy loans to homehowners or toxic financial assets.
After 2008, regulators required the banks to be much more capitalized, and they are today in a much stronger situation than they were.
If we look at the banks that failed, they had a business model in which the risk was skewed towards crypto (Silvergate), or towards startups (Silicon Valley), or had accumulated problems during the years (Credit Suisse).
Especially for the US banks, having a deposit base very concentrated on a certain category of customers, can lead to big problems because they may choose to leave at the same time.
European and large US banks have a much more diverse customer base, which is unlikely to leave at the same time.
What are the weaknesses of banks?
Is it all ok, then? Well, as we said, the banking sector is much stronger than in 2008. It is more regulated, more capitalized and had much less toxic asset to deal with.
Having said that, it has to be acknowledged that we have transitioned at light speed from the zero interest rates environment of the last 15 years to an environment in which interest rates are back substantially higher.
This unavoidably can cause some occasional incidents because of mismanagement by financial intermediaries of interest rates risk or for some other reason that is difficult to foresee in advance.
Financial markets, a huge, sophisticated and delicate system that can be shaken by changes of this magnitude. At the time of writing, anyway, it seems that the factors that caused so much pain to the financial markets in 2008 are absent.
What about inbestMe?
Lets’s think for one moment, what is the core banking business.
Banks usually finance themselves with short maturity liabilities (deposits) and invest in long maturity assets (mortgages, long term financial assets).
Usually, the interest they pay on deposit is lower than the interest that they get on long term investments. That is what makes their profit. Basically, it is the remuneration for running that mismatch of maturities.
But that mismatch of maturities is also what caused the problems for US banks. They saw deposits fleeing and had to liquidate at a loss long term assets.
These issues do not exist for inbestMe that does not run a traditional banking activity and is only an asset management company. inbestMe receives funds from clients and invest them in liquid assets in the name of the client. When a client requests back his funds, inbestMe just sells these assets. There is no maturity transformation from deposits to long term assets that can cause problems as the ones in which incurred the US banks.
You may be interested to read again: inbestMe is not a bank, why this may be better for you?