We assess the fallout from the failure of Silicon Valley Bank and the implications for the financial sector.
- We think the issue that brought Silicon Valley Bank (SVB) down was specific to smaller US banks. We do not expect similar issues to flare up in the wider global banking sector, as the balance sheets and liquidity positions of larger US and European banks remain strong.
- In our view, the collapse of SVB was largely symptomatic of two key factors: central-bank tightening to address inflation and light-touch regulation of smaller US banks.
- We believe opportunities remain within financials, and market volatility can provide the possibility to buy high-quality companies at attractive valuations.
No More Easy Money
In our view, the collapse of Silicon Valley Bank (SVB) was largely symptomatic of two key factors. The first of these is central-bank tightening to address inflation. The last decade saw a flood of easy money and low interest rates, and during that period interest-rate risk was not an issue banks had to face. Now, however, with interest rates higher, it is a different story.
US banks saw a large inflow of deposits during the period of quantitative easing following the Covid pandemic. Due to low loan demand, some banks invested these deposits into long-dated securities. The onset of quantitative tightening from the US Federal Reserve and the availability of better rates elsewhere led to deposit outflows for some of these banks, creating liquidity issues. In our view, the mistake these banks made was not to hedge their interest-rate risk because they were not forced to do so.
The second key factor that we believe played a part in SVB’s collapse was light-touch regulation in the US around smaller banks. Banks with assets of less than US$250bn in the US have lighter regulatory requirements, including no obligation to participate in stress tests, and they have lower capital and liquidity requirements.
At the other end of the scale, we believe large US banks are in a much better liquidity position given that they are subject to tighter regulations and, after recent events, are seeing inflows of deposits. In Europe, meanwhile, there are stricter regulations around liquidity, including the Liquidity Coverage Ratio and Net Stable Funding Ratio that European banks must adhere to. This is important to bear in mind in the context of recent European banking share-price volatility, with some company-specific issues also playing their part.
In the wake of SVB’s collapse, we think there is likely to be a regulatory tightening with regards to how the smaller banks manage interest-rate risk, and an extension of the stress-testing regime to smaller US banks.
We believe that changing interest-rate expectations, negative sentiment, the potential impact on credit availability, and some company-specific issues have been drivers of volatility over the last week.
A Buying Opportunity?
Nevertheless, despite the SVB episode, we believe that numerous opportunities remain within financials. In our view, large-cap US and European banks do not have the same issues that SVB faced. There are some emerging-market economies where inflation is under control and banks are profitable. Exchanges are benefiting from volatility in financial markets.
At times like these, it is easy to focus on the negative aspects, but we believe such events provide opportunities to buy high-quality companies at attractive valuations, and we believe this is exactly when it is important to look for those opportunities rather than avoiding risk completely.
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