WHAT THE BANK CRISIS IS ALL ABOUT AND SHOULD SINGAPORE BANKS BE CONCERNED

While it was not exactly the Black Monday Mar 13 that some feared, the banking sector in US got hit hard and the dust has still not cleared. What triggered the whole thing was not the bank run at Silicon Valley Bank, but investors who got spooked by private equity capitalists who advised their portfolio companies to pull out of the bank. As panicky investors dumped SVB the share price dived and depositors rushed to the bank to withdraw their cash.

Last week, apart from SVB, Signature Bank and First Republic Bank also collapsed. First Republic was similarly situated. Signatures problem was due to its exposure to crypto. Elsewhere, Credit Suisse is in big trouble. Its problems are due mainly to its investment banking business and several legal cases it is facing.

It's amazing how investors always follow the herd. Warning signs have been there for months. The 2 charts below never fail to explain. Rising interest rates during an inflationary time always cause a liquidity run as money rebalances in the market. It's as simple as that.

This is easily proven from data provided by the Federal Deposit Insurance corp. The chart below shows in the last 3 quarters of 2022 nearly US$700b flowed out of commercial banks.

The oft mentioned unrealised losses on long term securities due to rising interest rates are also shown in FDIC data. This always occur when the yield curve is inverted, which started sometime in April 2022. As short term rates rise, those holding on to long term securities will suffer valuation losses. The chart below show the commercial banking sector were showing huge unrealised securities losses. As at December 2022, US commercial banks had unrealised losses on combined Available-for-sale and Hold-to-maturity portfolios totalled a whopping US$600b.

The US$600b loss as shown in the chart is only unrealised loss on securities valuation. It does not necessarily translate to losses to the banks. Change in interest rates is a market risk and banks manage this risk. For example if a bank has an asset US$10m 10 year bond, but it has a long term 10 year borrowing, both written at about the same time, then it is squared. It does not suffer any losses. So do not panic just yet.

In the case of SVB, its unrealised securities loss was US$15b. SVB had US$173b long term securities, but only US$15b long term borrowing. There was a big mis-match. Their off-balance sheet did not carry much derivatives that means the huge securities holding was not hedged. The loss is real although not yet realised.

In my blog 27 Jun 2022 "How a bankrupt Fed cheats with creative accounting" I made an educated guess the Fed is hiding an unrealised securities loss of US$1T. That's an incredible number. As I explained in my blog 27 Jun 2022  "In defence of MAS S$7.4b losses - all central banks have nowhere to run",central banks live with the consequences of their monetary policies. This is true in the case of forex market intervention. For interest rates, it is possible to hedge. We don't know if both the Fed and Mas has done so.

MAS has commented that the US banking crisis do not affect banks in Singapore. In as far as the impact of rising interest rates on securities portfolio is concerned, the MAS is in a position to appreciate the situation. Banks in Singapore provide several reports to MAS. 2 of these reports are worth mentioning. (1) Maturity gap report; (2) Interest rate gap report. This allows MAS to monitor maturity and interest rate gaps or mismatches. Banks will be hauled in to explain when these gaps grow too huge.

The MAS however, got too ahead of itself to say the crisis does not impact Singapore. At the moment, the US regional banks are hit the worse. But if any international commercial banks in the US collapse, it will definitely hit Singapore banks. The failure of bigger banks will cause contagion effect in the financial markets because of counterparty risks. In the foreign exchange market the risk is minimised because a payment is offset by a receipt. It is in the money market and derivatives that will create great havoc.

Banks contain counterparty risks by setting internal limits. Each bank sets a maximum exposure they are allowed to trade with another bank by placing limits in each market such as FX, money market, derivatives, etc.

The Fed conducts stress tests periodically on the US banks but I do believe this test do not include maturity and interest rate mismatch (also called sensitivity) analysis, unlike the MAS.

Treasury Secretary Janet Yellen initially said of SVB there will no bailouts but flipped to provide 100% cover for all depositors by FDIC. The FDIC as at Dec 2022 has a fund balance of US$128b. How is it going to cover depositors 100%? Is the government biased by the fact SVB and Signature Bank are pretty much woke and supports the Democrats with much donations. All but one member of SVB board are Democrats. It was recently disclosed SVB donated S$73m to militant leftist Black Lives Matter organisation.

In a bank liquidation, depositors are considered as unsecured creditors and will receive from distribution of assets ranking parri passu with all other unsecured creditors. In the case of Singapore, depositors are insured up to S$75,000. In US the FDIC insures up to $250,000 per depositor.


Conclusion :

Rising interest rates to fight inflation causes liquidity stress in most markets that manifests in cash outflows in commercial banks. As banks maintain substantial holdings in securities for liquidity purposes, a rising interest rate causes losses in these securities if they are long-dated. If banks manage their interest rate gaps well, the losses on securities need not necessarily translate to bottom line losses. 

The market has been pushed to the cliff by rising interest rates and a black swan, which many expert voices have predicted is coming, will easily tip it over. It seems SVB is that black swan. In such circumstances, herd instinct drives the market. The huge overhang of unrealised losses on securities fans the fear, but in a market pushing over the cliff, panicky investors ignore the fact that banks which managed their interest rate gaps well will incur no losses. I believe there are good picks for shrewd investors during the mayhem.   

In short, Americans are killing their banks by elevating a liquidity problem into a solvency problem.

Note: Charts above are from FDIC. Data are all those commercial banks insured by FDIC which are the majority. The data  does not cover all banks in US.

This platform has withdrawn it's subscriber widget. If you like blogs like this and wish to know whenever there is a new post, click the button to my FB and follow me there. I usually intro my new blogs there. Thanks.