Key lessons in failure of America’s SVB 

Silicon Valley Bank (SVB), the largest commercial bank in Silicon Valley in America was put under regulatory administration last Friday after failing to raise new money to cover its funding shortfalls that were occasioned by realised impairments on its bond portfolio holdings. 

SVB was a niche regional bank largely serving the tech community in California’s Silicon Valley and its failure probably presented the largest banking failure since the 2008 global financial crisis.

The impairments on its bond book were in themselves largely a central banking anomaly.

For several years, central banks in the developed world especially the US Federal Reserve, had been scouring the ocean floor in search of a two percent inflation. 

As a consequence, they printed and provided large quantities of cheap money to financial markets (referred to as quantitative easing).

The US Fed, for instance, printed approximately $3.3 trillion in 2020 alone in order to counter the economic impact of the Covid-19 pandemic.

This money was pumped into the United States economy by buying bonds from financial institutions. 

The idea behind putting money into the economy was to drive down interest rates and hope that people and businesses borrow and spend more, and in the process revive the American economy.

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This action allowed private firms, such as SVB, to access funding at artificially low rates, which they then used to purchase government debt at equally low rates. 

Then the Ukraine-Russia war happened and global prices surged out of control. Central banks rushed to sterilise the massive amounts of liquidities in the system by unwinding and shrinking their balance sheets primarily by raising rates (something market participants christened as quantitative tightening).

The US Federal Reserve has continued to raise its base rate on US Dollar and the rate is now projected at around five percent (from 0.25 percent a year ago).

Similarly, the Bank of England (BOE) has raised its base rate on the Sterling Pound to 4.00 percent (and is yet to peak).

The European Central Bank (ECB) is yet to hit the peak of its interest rate on the main Euro refinancing operations and the interest rates on the marginal lending facility. 

As is the convention in fixed-income markets, when interest rates rise, bond prices fall. Banks then have to either re-adjust their holdings or seek funding to cover cash shortfalls, failure to which they run a risk of a run (which is exactly what has transpired).

As regulators race to seal transmission channels of SVB’s failure into global financial system through a series of open-mouth operations (OMOs), a central bank triggered bankruptcy may already be unfolding and probably could extend to the non-bank sector (especially the tech sector). But that notwithstanding, SVB’s failure offers three critical reflections.

First, bank regulators must now raise safety requirements for banks with high-concentration risks. It remains a puzzle that regional supervisors in a more sophisticated market like the US could allow SVB to build such high-concentration risks.

But perhaps this is also down to US’ very complex regulatory landscape. Even certain levels of holdings of government debt should now be classified as concentration risk, as has been evidenced in Ghana. 

Secondly, we cannot ignore the role of accounting standards and financial disclosure requirements. More fundamentally, the premise of IFRS 9 was for financial institutions to build sufficient buffers to withstand any shock(s).

Has the standard achieved this objective two years down the line? I doubt. The standard has two major weaknesses in my assessments: (i) it gives management too much room when it comes to risk judgment(s). When projecting the probability of default (PD), there are a number of micro and macro assumptions that are built into the forecasting model.

These assumptions create asymmetry in terms of risk judgments, and (ii) disclosure mechanisms haven’t helped cut opaqueness in financial institutions.

In fact, banks are now even more opaque than before, making it difficult to establish the quality of their financial assets.

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Finally, banks must move away from their penchant for wholesale funding as a long-term strategy, and place more emphasis on funding from grandpas and grandmas.

Unlike generation Z and institutional depositors, grandpas and grannies are generally not a flight risk.