Digital Zeitgeist – Banking Crisis Update 14.03.2023

A Sigh of Relief in The United Kingdom Regarding Silicon Valley Bank – Panic in The United States!

Sale of SVB’s British subsidiary to HSBC is a satisfactory fix but Fed emerges with less of a worthy halo.

The rescue plan for the United Kingdom branch of the failing Silicon Valley Bank was developed during the course of a single three-day weekend, which is excellent news. We no longer need our executives in the technology sector to write heartfelt letters to the chancellor extolling their indispensable role in the economic growth of the country. The unfortunate development is that the remedy proposed by US authorities for the considerably bigger parent bank has led to more questions than it has solved. The aftermath of SVB’s bankruptcy, along with the effects of Signature Bank’s demise, has the potential to become far more severe.

But, let’s begin with the bright side first. The deal between SVB and HSBC to sell their UK business to HSBC for one pound is favourable from practically every vantage point. The clients’ funds will be transferred to the largest bank in Europe, a safe haven they probably would have picked at the end of last week when their funds were frozen. They may now get an instantaneous withdrawal of their funds. The Treasury Department is going to be overjoyed by the fact that it did not put any public cash at jeopardy. The probable plan B, which included offering lines of credit to SVB UK’s clients, seemed like it would be an awful problem to deal with.

From an optical  standpoint, the conclusion is a home run for the Bank of England. It would seem that the stricter capitalisation criteria that were placed on the UK subsidiaries of international banks as a result of the post 2007/08 crash regulatory changes were successful in this particular situation.

We don’t know whether the governor had to put any pressure on HSBC to buy, but it’s possible that he didn’t: the buyer indicated that it was acquiring a UK banking business with tangible equity projected to be roughly £1.4 billion for its single pound of investment. The sum is susceptible to change; but, for HSBC, for which SVB UK’s loans of £5.5 billion and deposits of £6.7 billion are a drop in the ocean, it is worth taking a chance on. This is not the same as when Lloyds TSB saved HBOS in 2008 and ended up shooting themselves in the foot.

However, the situation in the United States is really concerning. SVB’s shareholders were always going to be wiped out, but in opting for a full bailout of SVB’s depositors, the US Federal Reserve and other regulators have sent several connected messages, very few of which are positive. These messages are connected by the fact that the US Federal Reserve and other regulators opted for a full bailout of SVB’s depositors.

First, they have given their approval to the concept that SVB represented a systemic danger, and as a result, the only appropriate response would be one that was comprehensive. This conclusion may be reasonable from a pragmatist’s point of view in the short term, but the ramifications for the long run are enormous. The position suggests, as Joe Biden hypothesised, that the United States will have to retighten the laws that apply to second- and third-tier banks. If the sixteenth biggest bank in the United States has the capacity to produce havoc, then it seems as if it should have been scrutinised more closely from the beginning.

Second, it appears that the lighter-touch approach that was supposed to apply to companies like SVB was not so much light as it was nonexistent. SVB was unable to succeed due to fundamental problems in risk management. The bank was flush with deposits, so it decided to take a chance on long-term debt issued by the United States, which soon lost value as interest rates increased. The bank was trying to increase its revenue by a little amount, but doing so exposed it to the possibility of a catastrophe in the event that its deposit levels dropped, and it was forced to sell portions of its bond portfolio, resulting in the realisation of losses. One would assume that a vigilant regulator would have seen the potential threat from a mile away. The question that immediately comes to mind is, “What Else Has Been Missed Elsewhere?!”

Thirdly, the Fed has fueled the speculation that SVB depositors who are well-connected venture capitalists received preferential treatment as a result of the bank’s favouritism towards them. The community of Silicon Valley, as opposed to the bank itself, pleaded with authorities to be exempted from the rule, and they complied.

If all depositors in all small banks – not simply those who fall inside the insured level of $250,000 (£205,000) – are also to be safeguarded in all situations, then this constitutes a major departure in the regulatory mindset that was previously held. The market is searching for clarification and is afraid of future bank run-ins, which led to the precipitous drop in the share prices of numerous US regional banks on Monday. Considering the current state of affairs, this drop is justified.

Another unintended consequence is that the financial markets are now uncertain about how they should react to changes in interest rates. A week ago, the chairman of the Federal Reserve, Jerome Powell, said that interest rates will need to climb in the coming months in order to bring inflation under control. So investors are wondering, in the interest of maintaining financial stability, if the rate rises would be postponed or will not occur at all. To put it plainly, the circumstance is less than ideal from the point of view of formulating public policy.

If you fast forward a week, there is a chance, although a small one, that things may seem to be in a more positive light. The Federal Reserve has further options available to it in addition to the emergency financing measures that were introduced over the weekend for financial institutions. But, we are also aware that the share prices of American regional banks do not plummet by exceptional percentages — 66% in the case of San Francisco’s First Republic at the beginning of trading – unless there is a genuine cause for concern. Congratulations to the Bank of England for a job well done. However, the real drama is taking place somewhere else.

online sources: theguardian.com, federalreserve.gov, fdic.gov

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