15/03/2023

There have been only two headlines in the last few days. Gary Lineker vs. the BBC (what he can and can’t say) and the collapse of SVB Bank. In all probability, unless you are in the business of investing in start-ups, you will have never heard of SVB Bank. It’s the 16^th largest bank in the US. The acronym of the name Silicon Valley Bank (SVB) gives you a clue as to where it's located and what it does. But it wasn’t always so. The Bank was originally a local bank lending money to farmers and wine growers of Northern California.

Like many small banks before and with parallels to the Savings and Loan collapse of the 1990s, SVB thought it had found a niche and opportunity to help fund all the nascent Hi-Tech start-ups in California and elsewhere that more traditional banks avoided. They were right and built up a name as the go-to bank to fund your new businesses. $200 billion of assets later they collapsed almost overnight like the former Soviet Union.

On the surface, such a fast collapse should not have happened as the balance sheets of banks, and the lending risk criteria attached to them had been vastly changed since the banking debacle that led to the Global Financial Crisis of 2008 (There is a caveat here - US regional banks are loosely regulated as compared to say the globally systemic banks or even the European regional banks). So what went wrong? 

A key contributor is inflation and related monetary policy, a secondary factor is the assets banks are allowed to buy and lastly, the behaviour of clients in a state of panic.

Inflation, being a general increase in the price of goods and services, if not dealt with quickly, can undermine and even destroy an economy. We have not had high inflation in the system since the 1970s and 80s.

This Economist is old enough to have lived through that period. For most, it is a new phenomenon. To try and safeguard the value of the bank’s assets as they increased to $200bn they are forced by law to buy supposedly safe or low-risk assets such as debt backed by the Government.  Now for the complicated bit. In order to both carry-on lending, and avoid inflation risk, banks buy Government debt called Treasuries in the US and Gilts in the UK.

These instruments are valued in inverse relationship to the interest they pay. Simply, if they pay 10% interest then this is deducted from the 100% value at maturity and the market price is 90. This is called Mark to Market. It could also be called Marked to Madness. Why? Because if the clients of the bank get scared, and all try and withdraw their funds at the same time, the bank is forced to sell these bonds now at 90 and lose the future value on maturity which would have been 100.

To cover this gap SVB then tried to raise finance in the market. This spooked the clients even more and caused an old-fashioned run on the bank. The same things that happened to Northern Rock and others. In reality, no bank keeps 100% cash or they would have no business.

 So what does this all mean?

The Federal Reserve (US Central Bank and the Bank of England) may slow their interest rate hikes.

Panic can cause further contagion and put even the bigger banks at risk. 

For the UK branch, SVB UK what transpired over the past weekend is in reality a Government bailout. Probably by secret assurances to the buyers and fall-back cash if the insurance monies aren’t sufficient. It just can’t be called that because of the adverse publicity it would cause.

The reason Governments on both sides of the Atlantic helped organise bailouts over the weekend was because if companies (in this case the depositors at SVB) had failed to pay their staff and suppliers, the knock-on effect, both economic and political, would have been far greater than doing nothing and watching the oh-so-sophisticated Venture Capital market panic en-masse. This is often referred to as ‘contagion’ - the spread of an economic crisis from one market or region to another, because markets are interdependent, events in one market can impact other markets. This can happen domestically as well as internationally.

Bank of England’s Governor – Asleep at the wheel again?

Since the collapse of SVB UK, The Treasury Select Committee has written to the Governor of the Bank of England asking for details on how SVB UK was supervised before its collapse, the Bank’s initial intention to place SVB UK into insolvency and its subsequent sale, how HSBC was chosen as a purchaser, and what lessons can be learnt from the episode about the regulation of banks and the post-financial crisis regulatory framework.

There has been concern for some time that smaller banks serving strategic sectors need more active prudential regulation. It will be very interesting to know if the Treasury sought assurances from HSBC on its approach to the UK tech industry as a condition of the purchase. There are also questions over reports that some tech firms were required to deposit funds with SVB UK as a condition of investment.

A number of questions remain around the effectiveness of bank regulation and resolution procedures, especially for smaller banks with a significant presence in strategically-important industries. It is important that these are interrogated and lessons learnt from the SVB UK episode to ensure that the post-financial crisis regime to avoid bailouts with taxpayers' money remains strong.

What now?

This has shaken the US banking system without collapsing it. The US regional banks are still under pressure. It remains to be seen if the recent Government actions will suffice.   

Start-ups, especially technology ones, will find it harder to get flexible banking and this will hit growth and undermine confidence. It will take a while to rebuild both.

The Governor, Andrew Bailey and senior leaders from the Bank of England are due to give evidence before the Treasury Select Committee on the collapse and subsequent purchase of SVB UK on the morning of Tuesday 28 March. It will be most interesting to hear their responses.

On the other hand, Gary Lineker will be back on Match of the Day next week, and both the Director General of the BBC and more importantly the 'compromised' Chairman of the BBC will eventually suffer from avoidable own goals. Banks rarely learn this lesson! 

Ian Morley

Treasury - True & Fair Party, Professional Investor and Economist