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Marktkommentar

Didier Bouvignies (Rothschild & Co): Silicon Valley Bank

© Rothschild & Co AM

14.03.2023 - The US financial sector was particularly rocked at the end of last week with the liquidation of Silvergate Capital, first, and then the bankruptcy of Silicon Valley Bank. This situation led to fears of a new "Lehman Moment(1)" that could have a domino effect on the global banking system.

A brief summary of  the facts

Silicon Valley Bank (SVB), a US regional bank (16th largest in the US by balance sheet size and with a capitalisation of 18 billion euros at the end of February 2023), recorded massive losses to honour withdrawals representing almost 25% of its 180 billion dollars deposits. This bank specialises in technology venture capital firms with a concentrated corporate client base was unable to meet these withdrawals. Indeed, SVB was forced to sell its long-dated government bonds purchased over the past few years to benefit from  more attractive yields than on shorter maturities. Given the recent rise in interest rates, the Institution thus recorded a considerable loss of value, forcing it to adjust its solvency ratio and to launch an unprepared capital increase which, as a result, was not successful. A situation that led to its bankruptcy. As a result, the bank faced a "bank run", i.e. deposits leakage leading the FDIC(2) to intervene and guarantee the assets of its clients.

Is there a risk of contagion?

  This bank failure, the largest since Lehman Brothers, has rekindled memories of a risk of contagion to the entire global banking system, similar to the great financial crisis of 2008-2009. This event also illustrates the consequences of a rapid and significant increase in central bank deposit rates, notably by the Fed. Indeed, in the US market, the unrealised losses of the bond portfolios recorded by the whole banking system represent about 600 billion dollars(3). It should be noted that in a stable deposit environment, the risk of losses would remain low. Nevertheless, the comparison with 2008 seems excessive. At that time, the crisis was about subprime mortgages worth $11 trillion, for which US households had taken on floating rate debt and were facing an inability to repay. Now, the banks solvency has improved considerably, with the average Tier 1(4) capital ratio of US banks having risen by 40% since 2008 and loans now representing 70% of deposits, compared to almost 100% in 2007(5). The potential consequences also appear to be much more limited in scope, as the Fed quickly stepped in to guarantee deposits beyond the statutory $250,000 guarantee and lending facilities. Moreover, this situation concerns regional banks more than large national US banks. The spread to European banks should be put into perspective. Although rates have risen at a similar pace in Europe and in the United States, they remain at much lower levels. Moreover, the area is made up mainly of national generalist banks with less exposure to the technology sector. . 

What are the implications for the global economy?

 Recently, market operators had been concerned about the continuation of price rises, particularly in the core(6) component. This dynamic had led to rate hikes, even inverting the curves(7) to a level not seen for 40 years, with a spread between 2-year and 10-year rates in the United States of -110 basis points(8). These events generate a "flight to quality(9)" across the entire yield curve, materialising in a reduction of the inversion by almost half, thus limiting the losses of bond portfolios. But above all, they may encourage central banks to integrate them into their monetary policy, as the spontaneous fall in demand for credit, in an uncertain context, limits the need to increase the cost of this credit. At this stage, it would be premature to estimate the impact on the real economy. Nevertheless, this event could revive fears of recession. Moreover, it demonstrates the inherent complexity of setting monetary policy following a prolonged period of extremely low rates. The return to normality generates shocks, which are inevitable, but which, if managed effectively, will not be able to reproduce an earthquake similar to the one that occurred during the crisis 15 years ago. As is often the case, although indirectly affected, European markets react vigorously to a shock from the US. However, this reaction should be seen in the light of their strong rise and outperformance over the past six months, as well as their low liquidity, due to the absence of long-term structural investors, such as pension funds.

 


(1) A situation in which the problems of a company or a seemingly minor component of the economy turn out to be so large that it becomes widespread. (2) Federal Deposit Insurance Corporation, an independent agency of the US government whose main responsibility is to guarantee bank deposits made in the US up to $250,000. (3) FDIC, T4 2022. (4) Core capital, (ordinary shares and investment certificates, minority interests) (5) Source: FDIC, Bloomberg, JP Morgan Asset Management, Q4 2022. (6) Excluding food and energy. (7) Graphical representation of bond yields according to their different maturities. In a stable economic environment, without inflationary pressure and excessive debt, interest rates increase with the maturity date of the bond. (8) Source : Bloomberg, 13/03/2023. (9) A crisis situation in which investors seek to sell assets deemed risky to buy assets deemed safer.

 

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