Goldman Sachs believes that the expected 50 basis points (bps) rate hike to be announced by the Federal Reserve on March 22, may not materialise. On March 12, the US Treasury, Federal Reserve, and Federal Deposit Insurance Corporation (FDIC) made two major policy announcements intended to stabilise banking system in response to recent bank failures and the risk of continued deposit outflows.
“We expect these measures to provide substantial liquidity to banks facing deposit outflows and to improve confidence among depositors. In light of recent stress in the banking system, we no longer expect the Federal Open Market Committee (FOMC) to deliver a rate hike at its March 22 meeting with considerable uncertainty about the path beyond March,” a Goldman Sachs report dated March 13 says.
On March 12, US banking regulators announced a plan to backstop depositors at SVB, suggesting that a systemic fallout may be averted.
Depositors at both failed SVB and Signature Bank in New York, which was closed on March 12 in a separate problem, but over similar systemic contagion fears, will have full access to their deposits. Signature Bank was a popular funding source for cryptocurrencies and had ties to FTX, so its downfall is not a surprise (especially in the current environment), notes Paul De Vierno, strategist at UOB Kay Hian Wealth Management.
“Regulators are probably glad to see [Signature] gone. They were always worried about the risks of links between crypto and the regular banking system. US futures are pointing to a higher opening when trade starts later today (Monday, March 13), but markets will remain concerned about other banks showing up with problems, before the bulls get excited about the way that bond yields and rate hike expectations have dropped since SVB failed,” De Vierno cautions.
Goldman Sachs points to a few factors that could avert a financial meltdown. First off, the FDIC has used the ‘systemic risk exception’ (SRE) to protect uninsured depositors in two bank resolutions, Silicon Valley Bank and Signature Bank. “In both cases, the costs not covered by the banks’ assets would be funded out of the FDIC’s Deposit Insurance Fund (DIF), which had a US$125 billion balance as of 4Q2022. The SRE waives the requirement that FDIC resolution uses the method that is least costly to the DIF,” Goldman Sachs explains.
Secondly, the Fed and Treasury also announced the Bank Term Funding Program (BTFP), which would provide advances of up to one year to any federally insured bank that is eligible for discount window access, in return for eligible collateral (generally Treasuries and agency securities). This will allow banks to fund potential deposit outflows without crystalising losses on depreciated securities.
The loans are made with “recourse beyond the pledged collateral to the eligible borrower” suggesting that the par valuation of the collateral would only become relevant if the borrowing institution lacks sufficient assets to repay the loan. The facility is backstopped with US$25 billion from the Treasury’s Exchange Stabilisation Fund (ESF), which has a net balance of US$38 billion.
Both of these steps are likely to increase confidence among depositors, though they stop short of an FDIC guarantee of uninsured accounts as was implemented in 2008, the Goldman Sachs report suggests.
“In light of the stress in the banking system, we no longer expect the FOMC to deliver a rate hike at its next meeting on March 22 versus our previous expectation of a 25bp hike. We have left unchanged our expectation that the FOMC will deliver 25bp hikes in May, June, and July and now expect a 5.25-5.5% terminal rate, though we see considerable uncertainty about the path,” Goldman Sachs says.
Before market participants cheer too much, note that market risk could increase. “The SVB episode demonstrates that portfolios duration risks can trip up financial institutions readily as rates rise,” observes Taimur Baig, Chief Economist at DBS Group Holdings. The sharp hikes in rates have made around capital raising, debt servicing, and portfolio risk management ‘dramatically more challenging’ he says.
“This risk transcends banks; sovereigns and corporations worldwide have the same issue. Rising rates have a wide range of negative implications for the property sector, which thrives on leverage,” Baig says in a March 13 report. Additionally, mortgage-backed securities could also be at risk. In the meantime, a housing price correction would create stress for bank and non-bank financial institutions, he points out.
Either way, the Singapore banks are experiencing a sell-off in the short-term. Further out, the greatest growth in their net interest margins and net interest income may be over for the time being as the path of rate hikes is uncertain. Additionally, the local banks funding costs are catching up.
Maybank says in a recent report that it expects asset quality risks to rise given the likelihood of a recession in the US. On the other hand, Lim & Tan points out that the local banks remain resilient and liquid. Both DBS and United Overseas Bank have ample management overlays while Oversea-Chinese Banking Corp has increased its overlays.
“Our Singapore banks today are well capitalised and have ample provisions to weather any need for write-downs, and are ranked amongst the strongest and safest in world rankings and benchmarks. We see any share price decline in the Singapore banks today as an opportunity to accumulate as we think 1) The contagion effect of a bank run should not spread to Singapore due to our local bank’s strength and 2) This will not cause a financial collapse as SVB’s depositors have been guaranteed with the setting up of a new lending program by the Fed,” says a research note by Lim & Tan.
