banking crisis spread

March has been a quite turbulent month for the global banking industry. It has only been less than 2 weeks since Silicon Valley Bank (SVB) announced bankruptcy, and now Credit Suisse is now grasping for help as their shares and bonds slumped. Though it was thrown a $54 billion lifeline by the Swiss central bank on 16 March, it does not defy that even the world’s largest financial institutions are not immune from economic crisis.

In the American banking system, a lot of ratio rules such as net stable funding ratio and liquidity cover ratio only apply to banks with $250b in assets. Currently there are 4157 commercial banks in the US, and only 13 banks among all those which own more than $250b. This means, the ratio rules are not applicable to the other 4144 banks. The US accounting system has also been peculiar since 2008, in which short term assets can be marked as profitable loss in profit/loss statements. As the asset changes in value, the value on the balance sheet changes as well, and the difference goes to the profit/loss statement. The loss from long term assets to maturity assets do not have to be declared, therefore it won’t be visible in the profit and loss figures.

SVB went and bought 10 year treasury bonds with it which seemed like a good idea at the time. As interest rates were zero, SVB could get one percent returns from the treasury bonds and pay a little bit of interest, and it would make a difference. However, the value of treasury bonds fell from $100 to $80, because as yields go up, price goes down. The portfolio was yielding it an average 1.79% return, far below the current 10-year treasury yield of around 3.9%. SVB’s asset value went down around $21b due to the sale of treasury bonds, and original investors were then told that the loss was greater than their Capital base, so technically the bank was insolvent.

Rumors are swarming as to whether Australian banks are safe, so extending this to the Australian context, capital adequacy requirements that these banks face in the US and here in Australia are a fair bit different. Australian banks are very heavy lenders and unlike the US where traditionally a lot of the lending is done at fixed rates for long periods, Australia focuses more on fixed short term lending and over longer term periods tends to be variable.

Could what is happening in the US and European Banking system spread here?

We talk about this and much more in this week’s EFG Podcast. Watch below.