It is hard for Australians to believe, but the US has 4,800 banks. That is one bank for every 70,000 people. In Australia, the ratio is one bank for every 260,000 people. This makes the US hugely over-banked by Australian standards which leads to all sorts of outcomes – good and bad.
The good created by having many banks results in greater competition, which means business and personal customers – depositors and borrowers – get very competitive deals. Not surprisingly, the bad is the reverse of the good – where competition forces slimmer profit margins, intense competition for talented people to run them, and higher risks of bank failure.
Just in the past week two banks, Silicon Valley Bank and Signature Bank have failed, leaving depositors of other banks nervous, and sending shock waves through stock and bond markets. Since 9 March the S&P 500 index in the USA has fallen 2.28%, while bond markets have seen yields fall, an indicator of expected recession.
Around the world, the banking sector has been hit quite hard by the uncertainty spreading from the US. Here in Australia, Commonwealth Bank is down 4.09% since 10 March, while nab is down 5.56%.
The bank run
The failure of Silicon Valley Bank (SVB) the 44th largest Bank in the USA, and the second largest bank failure in history, is in many ways a story of poor regulation as much as poor management.
It appears SVB was very strong at cultivating relationships with Fintech companies and had many millions of deposits from start-up companies. It also took many millions in deposits during Covid. The problem for SBV is that it did not have a strong lending base. When a bank takes deposits, it then needs to do something with the money to return a profit. Normally, banks use deposits to lend to businesses, home loans and personal loan customers, and for credit card lending. Banks are normally very careful to manage their capital base to ensure their deposits and liabilities are well matched – that is, when a depositor calls on their money, the bank needs to be able to repay it.
Instead of lending the deposits, SBV invested them – in unhedged long-term bonds. As interest rates increased, the value of these bonds fell. At the same time, their Fintech company depositors began withdrawing money to be used in funding their operations in a difficult environment. If too many depositors want their money back all at once, it’s a problem, because the cash isn’t out the back in a safe – it’s loaned out, or in the case of SVB, it was invested in loss-making investments.
When depositors smell a rat, they withdraw their cash and that’s how a run on a bank happens.
The Australian experience…a much stronger outlook
Banks here in Australia are very different to US Banks. As we mentioned earlier, we have relatively few banks and they are heavily regulated and supervised by APRA. (Australian Prudential and Regulatory Authority). APRA requires banks to hold high-quality liquid assets equal to an estimate of a bank’s short-term cash outflows under a situation of significant stress. Our regulators were on alert for any direct or indirect exposures to the failed US banks – which they expected to be limited.
An Australian Prudential Regulation Authority spokesman said: “APRA is closely monitoring the situation and potential impacts for the Australian financial system caused by the collapse of the Silicon Valley Bank in the US on 10 March 2023.”
“Australia’s financial system is strong, our banks are resilient, well capitalised and have strong liquidity coverage,” APRA‘s spokesman said.
The silver lining
There’s a cruel twist of irony in this story. As the markets reacted to the news of the two bank failures, a problem that caused the crisis has reversed sharply, with the U.S. 2-year Treasury yield declining by 0.68% since Wednesday of last week.
This means the loss-making investments SVB made, are probably looking more profitable right now.
As this chapter of the pandemic recovery plays out, it’s possible that the Australian interest rate hiking cycle may also have come to an end. It has caused a rethink of the path of Australian cash rates, with the market now pricing only an 11% probability of an RBA cash rate increase next month.
Is there any response required?
The mechanism we use to process the risk of financial loss is the same as the way we process the risk of mortal danger – it is only natural to be concerned by the current situation. We must however not let emotion and short-term noise undermine our investment decisions.
Market shocks are unsettling for sure, but our long-term investments are exactly that, long-term. While a good crisis may have us reaching for something to calm our nerves, we need to look through to the calm on the other side of the crisis.
In some good news, the exposure to SVB and Signature Bank in our client share portfolios is negligible, while in bond portfolios, the exposure is nil. This is a benefit of running very diversified portfolios.
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