If the VIX is anything to go by, the market is nowhere as worried about the failure of three mid-sized US banks — Silicon Valley Bank, Signature Bank and Silvergate Bank — as it was when Lehman Brothers collapsed in 2008.
Even the collapse in Credit Suisse Group’s share price between March 13–15 left the VIX, often referred to as the Fear Index and a popular measure of the stock market’s expectation of volatility based on S&P 500 index options, unmoved.
The VIX or Chicago Board Options Exchange’s Volatility Index rose from 18.5 on March 2 to 26.5 on March 13. But at the close of the US markets on March 15, the VIX was still hovering around 26.
The VIX has seen higher in the past. It surged to 65 at the start of the pandemic in 2020 from an average of 17–18 in the previous six months. In 2008, the VIX went to 80 twice from an average of 17 in 2007. The calmer markets may indicate a lower likelihood of contagion.
As it is, the Swiss National Bank (SNB) has acted swiftly, providing Credit Suisse with a CHF50 billion ($72.5 billion) liquidity facility, should it need one. The SNB is also prepared to buy back Credit Suisse’s troubled bonds if necessary. These include US$2.5 billion of senior dollar-denominated debt, Euro 500 million of senior Euro-denominated debt and CHF3 billion of senior debt facilities.
On March 15, SNB and the Swiss Financial Market Supervisory Authority FINMA announced that “Credit Suisse meets the capital and liquidity requirements imposed on systemically important banks. If necessary, the SNB will provide CS with liquidity.”
See also: A balancing act between capital and liquidity
The sharp decline in Credit Suisse’s share price on March 15 was triggered by a remark from the chairman of the Saudi National Bank (SNB), which owns nearly 10% of Credit Suisse shares. When its Ammar Al Khudairy was asked if he was willing to inject more cash into the lender, he responded: “Absolutely not.”
Yet, the following day, he backtracked on his words. He says Credit Suisse is generally “sound”, that SNB wasn’t asking for more capital, and that the panic he sparked off the day earlier was “completely unwarranted”.
Meanwhile, politicians on Capitol Hill are blaming the failure of the three US mid-sized banks on the Reform Law of 2018, signed into law by Donald Trump, which rolled back some of the regulations in Dodd-Frank. Under the Reform Law, banks with assets of less than US$250 billion ($337 billion) need no longer be subject to stress tests regularly and stricter liquidity requirements that larger banks have to comply with. SVB, which caused some market panic, had assets of less than US$250 billion. In 2018, opponents of the Reform Law had argued the changes could open taxpayers to more liability if the financial system collapses or increase the chances of discrimination in mortgage lending.
See also: SVB collapse unlikely to cause systemic risk, say analysts
“The failures of SVB and Signature Bank reveal fragilities within the US banking system, particularly as it pertains to regional institutions,” note PGIM Fixed Income spokespersons in an update on the saga.
On March 15, The Financial Times reported that the US Federal Reserve is looking at tougher rules, including capital and liquidity requirements and regular stress testing, for mid-sized banks with assets of US$250 billion and below.
Prelude to a meltdown
So what happened earlier this month?
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California-based SVB failed three days after the release of its Strategic Actions/1Q2023 Mid-Quarter Update on March 8. In the update, SVB announced the sale of substantially all of its Available for Sale (AFS) securities portfolio. The reason for the sale included “repositioning SVB’s balance sheet to increase asset sensitivity to take advantage of the potential for higher short-term rates” on the expectation of “continued higher interest rates, pressured public and private markets, and elevated cash burn levels from our clients as they invest in their businesses.”
However, given the impact of rising interest rates, SVB announced that for the US$21 billion in AFS sold, it would recognise a preliminary estimated realised loss of US$1.8 billion. This action, along with the announcement of plans to raise about US$2.25 billion in capital from common equity and mandatory convertible preference shares, created something of a bank run.
SVB’s share price fell sharply while deposit outflows accelerated with — according to a filing by California regulators — depositors trying to withdraw US$42 billion of deposits on March 9, or 25% of SVB’s total deposits.
On March 10, the bank faced “inadequate liquidity and insolvency”, forcing the California Department of Financial Protection & Innovation to shut down SVB with the Federal Deposit Insurance Corporation (FDIC) named as receiver and taking over SVB’s US$175 billion in customer deposits.
If Jerome Powell and the Fed are being seen increasingly as partially responsible for the pain financial institutions are bearing, they are trying to redeem themselves by calming markets and depositors.
On Sunday, March 12, the Treasury, Fed and FDIC announced in a joint statement that the FDIC would protect all depositors of SVB. In New York, Signature Bank was closed by its state chartering authority because of its association with crypto assets. However, its depositors will be saved.
The trio said in their joint statement that “shareholders and certain unsecured debt holders” would not be protected and senior management would be removed. Any losses to the Deposit Insurance Fund in support of uninsured depositors would be recovered by a special assessment on banks.
The Fed also announced that it would provide additional funding for eligible institutions through a new facility entitled the Bank Term Funding Program (BTFP). The fund will offer loans up to one year to eligible banks, savings associations, credit unions, and other depository institutions pledging US Treasuries, agency debt and mortgage-backed securities, in addition to other qualifying collateral. The assets will be valued at par.
In its announcement, the Fed said the facility will be “an additional source of liquidity against high-quality securities, eliminating an institution’s need to quickly sell securities in times of stress”. The Fed will also make adjustments to the discount window, its traditional lending facility that provides ready access to funding during periods of financial stress. In particular, the discount window will now apply the same margins used for the securities eligible for the BTFP, thereby increasing the lendable value at the discount window.
The BTFP will be backstopped by US$25 billion from the Exchange Stabilization Fund (ESF). Meant to be a temporary solution, the ESF was used during the pandemic when US$50 billion was pledged from the fund to cover any losses in new lending programmes. The ESF was also used in this capacity during the 2008-09 Global Financial Crisis. For example, funds from the ESF were used to temporarily guarantee deposits in certain money market mutual funds.
“In our view, by standing up the BTFP, the Fed is taking a page out of its traditional finan cial crisis response playbook. During a financial crisis, the Federal Reserve, to avert panic, should lend early and freely (without limit), to solvent firms, against good collateral, and at penalty rates of interest,” Bank of America (BofA) says.
By lending freely, the Fed can sidestep a credit crunch. “During times of crisis, history suggests the central bank can avert destructive fire sales, bank runs and other demands for liquidity by providing a virtually unlimited source of liquidity. If successful, adverse second-round effects of plunging asset values, reduced household wealth, and severe credit contractions can be avoided,” BofA adds.
Wrong timing too
In a separate development, Credit Suisse’s price collapse was caused by a culmination of factors which boiled down to wrong timing. In 2021, Credit Suisse had announced a reorganisation to reduce its investment banking business after losses tied to hedge fund Archegos and financial service company Greensill.
Besides the damaging remarks made by the chairman of its largest shareholder on March 15, Credit Suisse reported a net loss in FY2022 and its annual report showed continued outflow of clients and funds; and more importantly that the bank was using its liquidity buffers which impacted its liquidity coverage ratio and net stable funding ratio.
“Sentiments towards Credit Suisse were not materially harmed despite persistent negative news flow through 2023. This changed rapidly on the collapse of SVB. Current negative market sentiments to the Financial Institutions sector and the spectre of contagion risk created a significant complication against the recent developments at Credit Suisse,” notes Andrew Wong, vice-president at OCBC Credit Research.
While Credit Suisse’s liquidity and capital position were above minimum requirements in its 2022 results (it had a CET 1 capital ratio and liquidity coverage ratio of 14.1% and 144% respectively), contagion fears linger.
“In times like these, contagion concerns become amplified and more so given Credit Suisse’s position as one of 30 global systemically important banks identified by the Financial Stability Board. The divergence of factors at play (statements of support from authorities and signals of distress in the market) and the breadth of outcomes are skewed to the downside,” Wong says in a March 16 update.
Rate hike cycle to abate
In the US, despite the stresses in the system, especially among the small and mid-sized banks, BofA does not expect any change in monetary policy.
“At present, we have not altered our outlook for monetary policy of a 25 bps rate hike in March. We continue to expect the Fed to raise its policy rate by 25 bps at its meeting on March 21– 22. In our view, and in light of ongoing market volatility from concerns around some regional banks, we did not see February’s employment report as robust enough to warrant a 50 bps rate hike. Our outlook for the terminal rate remains unchanged at 5.25%–5.50%,” BofA says.
“In our view, if the Fed is successful at corralling the recent market volatility and ring-fencing the traditional banking sector, then it should be able to continue its gradual pace of rate hikes until monetary policy is sufficiently restrictive.”
On March 12, Goldman Sachs issued a report stating it expects the Fed to not raise interest rates this month. However, it expects the FOMC (Federal Open Market Committee) to announce a 25 bps hike in May and continues to expect a terminal rate of 5.25%–5.5%.
Elsewhere, the views are mixed with the chances of a hike on March 21–22 at 50:50. “SVB’s demise will pressure central banks into slowing interest rate hikes. Central banks will now have to consider the impact of any further interest rate hikes on the stability of the financial system. We now expect an earlier end to quantitative tightening in the US (the running down of central bank bond portfolios) than previously anticipated. We expect a 25 bp rise by the Fed but don’t rule out the US central bank keeping rates on hold in March,” says Arun Sai, senior multi-asset strategist, Pictet Asset Management.
February’s inflation numbers may put the Fed in a quandary. The US Labour Department said that the Consumer Price Index rose 0.4% m-o-m on a seasonally adjusted basis and by 6% y-o-y, the smallest annual increase since September 2021. While the monthly and annual rates are lower than previous levels, inflation remains elevated.
“The latest inflation and employment reports reaffirm our view that the Fed is not done with tightening yet, given continued wage growth and the price developments seen in housing, food and services costs,” says Alvin Liew, senior economist, UOB global economics & markets research.
“Admittedly, the recent US banking sector developments have raised concerns as there may be contagion risks surfacing elsewhere, complicating Fed’s inflation fight as price concerns are now swirling in a pot of financial market uncertainty. As the recent US regional bank’s collapse is viewed more likely as an idiosyncratic development and unlikely to have a systemic impact on the US financial sector, it is reasonable to expect the US Fed to continue to stay focused on fighting inflation and push forward with its rate hike cycle. Thus, we still expect another 25 bps hike at the upcoming March FOMC,” he adds.
Specifically, Asean is unlikely to be too adversely impacted by the SVB-Signature Bank-Silvergate Bank collapse.
“Major Southeast Asian banks might not face the deposit flight scenario that toppled SVB, given a healthy liquidity profile amid rising rates. They have a strong core deposit franchise and modest unrealised investment losses on securities. Funding-cost drags look manageable for the lenders due to ample liquidity in most systems and sizable Casa ratios,” says Rena Kwok, a credit analyst at Bloomberg Intelligence.
In Singapore, the Monetary Authority of Singapore (MAS) has announced that Singapore’s banking system remains resilient and that the Singdollar money market and foreign exchange markets are continuing to function well.
MAS adds that Singapore banks have insignificant exposures to the failed US banks and that they are well-capitalised and stress-tested regularly. It also adds that their liquidity positions are healthy, supported by a stable and diversified funding base. MAS says it stands ready to provide liquidity through its suite of facilities to ensure that Singapore’s financial system remains stable.
All three local banks have also reiterated that they have no direct exposure to the US banks and pointed out they have sufficient capital, liquidity and coverage to ride through the stresses and strains of the fallout, albeit limited so far.
Still, investors shouldn’t be complacent. The regulators may have won the battle but not the war. Edmund Chan, director, Tiger Brokers (Singapore), says US regulators have not addressed the underlying issue, which was caused by the drop in bond values as a result of rising interest rates. All banks have to hold these high-quality liquid assets (HQLA) and they are the numerator in the liquidity coverage ratio.
“Potential unrealised losses are sitting on the SVB’s books, but it doesn’t take into account the potential gains for the interest rate hedges, hence the lack of visibility. This problem could be glossed over if the US Fed embarks on an aggressive rate-cutting cycle, but with high inflation, it may not be possible. The US Fed will thus be forced to push ahead with bigger rate hikes which will worsen the “unrealised losses” on the bonds portfolio held by the US banks,” Chan says.
Increasingly then, all eyes and ears will be on the Fed come March 21–22. And the VIX may surge again, especially if a couple of weaker European banks rock the boat.