Business Maverick

BUSINESS REFLECTION

After the Bell: Banks and the ghosts of futures past

After the Bell: Banks and the ghosts of futures past
A security guard watches a customer leave a Silicon Valley Bank office on 13 March 2023 in Santa Clara, California. (Photo: Justin Sullivan / Getty Images)

Ever since the 2008 Global Financial Crisis, or GFC as it is now known, the idea of a new banking crisis freaks out the entire financial system more definitively than Scream VI. Oh, didn’t you know? Yes, there are in fact now six versions of the Scream horror movie franchise, posing the question of just how much screaming a movie franchise can do. Turns out a lot.

What the global markets are going through now is the build-up phase when Ghostface (a character in the Scream horror movie franchise) lurks in a dark church/theatre/house with a very large chopping knife with an oddly underdressed young woman who finds herself trapped in said church/theatre/house and is creeping around fearfully trying to find the exit. Quite soon, she will walk into Ghostface and there will be screaming. But at this particular moment, there is an awful, expectant lull, with lots of creaking floors.

We caught a glimpse of financial Ghostface this past week, when Silicon Valley Bank (SVB) in the US collapsed, leading everybody in the world (especially bankers) to wonder whether we are on the verge of another lurid, screaming global financial crisis that will nullify our precious savings in yet another a bonfire of the bankers.

So, now, technically speaking, the answer to that is a definitive no, but the sad truth is that you can never say absolutely never when it comes to banks, for reasons I will explain. Clearly, there are some jitters in the markets; all of SA’s banks (other than FirstRand) have taken a bit of a hit over the past week, a little more than the market as a whole. And they are in the company of banks around the world.

The reason that the failure of SVB (which, by the way, is the second-largest bank failure in US history) won’t necessarily affect the global banking system vests in the name of the bank, as my podcast mate Mark Barnes noted in our forthcoming edition (out tomorrow) What happened here is that someone had a great idea for a bank (over a poker game, as it happens — I am not making this up) and said, let’s provide banking services to all the Silicon Valley startups — they have money coming out of their ears. And we will get invited to some fabulous parties, where we will utter the word ‘blockchain’ loudly and often, whereupon people will throw that money at us.

And it happened! It was a great idea, but it’s a characteristic of great ideas that when the wind changes direction, great ideas can become bad ideas faster than you can pivot to the new reality. In some ways, that is exactly what happened to Silicon Valley Bank. SVB’s deposits more than quadrupled from $44-billion at the end of 2017 to $189-billion at the end of 2021. But the curious thing is that its loan book only grew from $23-billion to $66-billion.


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Normally, banks make money, very broadly speaking, from borrowing long and lending short. The reason they can do this is that interest rates on longer loans are typically less than on shorter loans, so banks pocket the difference. But in the case of SVB, its startup clients actually had lots of money already from other sources: start-up funding, venture capital, IPOs, etc. What they needed was a place to store the cash, while they burnt through it building all those businesses that are going to change the world.

Saddled with lots of cash, SVB did the sensible thing: invested it into safe assets that could be easily liquidated, and that generally means government bonds. But as interest rates go up, the market value of those bonds goes down. Eventually, the situation for SVB became intolerable, and it sold its entire bond book for a $1.6-billion loss, intending to make up the difference with a capital raising exercise.

But it didn’t happen that way; the word got out — and in Silicon Valley, when the word goes out, it really goes out — that the bank would have to raise capital, and everybody rushed to the bank to withdraw their money parked there. End of bank.

In addition to this problem, there is something more subtle at work, too. Bloomberg columnist Matt Levine pointed out in his comment on the situation that startups are, generally speaking, a low interest rate phenomenon. When interest rates are low, then current money will be worth the same as future money, more or less. So, investors are happy to see startups use today’s money to (possibly) make money tomorrow. But if today’s money is going to be worth more than future money, well, investors might be inclined to want to see some sort of cash flow to compensate for that loss.

So, how does this all affect banks around the world in general, and those in SA in particular? Well, as irony would have it, SA’s banks have all just reported either annual or interim results, and they were fabulous. Standard Bank reported it had made more money off a larger turnover than it ever had before. The other banks were in the same loose category.

For ordinary commercial banks, the first phase of rising interest rates is a boon. This is because they pay more interest on their borrowings, but they get paid even more on their lendings. As Robert Armstrong noted in the Financial Times, rising interest rates help the asset side of the balance sheet of banks more than they hurt the liability side.

So … it’s all right then? Particularly since the US government has decided to support SVB depositors, notably unlike during the GFC when the government used taxpayer money to support the banks themselves rather than their customers.

Well, not so fast.

The problem is that the collapse of SVB alerts us to the fact that nearly all banks are sitting on unrealised losses in their bond portfolios — big ones. I mean really big ones. Fortunately, loan books in most banks, unlike SVB, make up a much larger share of assets than their bond portfolios. And those loan books are earning more, as the financial results of SA banks show. Yet, there is a potential problem looming here that needs to be quantified pretty sharpish.

What SVB also shows is that higher interest rates hurt. They just do. They are meant to. They might not hurt the way Ghostface’s knife hurts, but they tend to take the froth out of the economic system, and there are few things more frothy than startup banks. US interest rates are due to rise even more, and the world will inevitably follow; this is a moment for investors to be especially cautious. DM/BM

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  • virginia crawford says:

    Central to the collapse of this bank was that regulations put in place after 2008, were rolled back by the Trump administration. The regulations meant that there was more scrutiny and that a bank had to have a certain amount of reserve funds in case of crisis. These regulations would have prevented the sudden expansion of this bank. I believe the regulations for banks with holdings of between $50 and $250billion were removed, so technically there are many other banks in a similar position. An article on our local banks safety provisions would be useful. Interesting to me is how opponents of any government assistance to the poor, run squealing for government bailouts, ala 2008.

  • Pierre Marais says:

    I think it’s borrow Short and lend Long, Tim.

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