The financial markets across the globe were shocked at the collapse of SVB. The collateral damage on account of its failure was immense. In the melee of sell off in global stock markets following the debacle, wealth of millions of investors was eroded. The pressure within the bank on account of interest rate hikes was building up since September 2022 and things took a turn for the worse on March 10.
SVB, a regional bank in the US, was a well-positioned bank operating since 1983. It celebrated making it to the Forbes magazine’s annual ranking of best banks in America for the fifth consecutive year. Its client base was of a niche segment. Its borrowers and customers are predominantly tech companies, start-ups and Tech HNIs. Investments flowing into these start-ups flows as deposits into SVB.
When interest rates were ultra-low during pandemic times, investments into start-ups surged. As a result, SVB got a massive spike in its deposit base from $61.76 billion in December 2019 to $189.20 billion by the end of December 2021. The trend exacerbated risks of asset liability management (ALM). The asset size of SVB reached $211.8 billion. Hit by Covid, the large-scale deployment opportunities to create loan assets were low.
ALM risks are managed by using structural liquidity framework. It is designed to capture the behaviour of residual maturity pattern of assets and liability of the bank, to measure liquidity gaps in different time buckets. The RBI prescribes 11-time buckets to capture such ALM gaps. Depending upon surplus or deficit position of liquidity in the respective time buckets, strategies are worked out to meet the gaps.
Many banks create simulated gaps and conduct stress tests and back tests to assess their resilience to cope with ALM risks. Even the strategies of ALM management in different banks could be different except that the banks have to necessarily plan to meet the liquidity gaps at least cost, using the liquidity windows provided by the regulators to avoid default.
When the accumulated deposits of SVB could not be deployed in credit, they were channelised into investment portfolio increasingly exposing it to market risk. An sum of $80 billion was invested in mortgage-backed securities (MBS) with 10 years + duration with a weighted average yield of 1.56 per cent.
In order to manage the yields and mark-to-market (MTM) losses, the bank chose to have a higher proportion of HTM instruments vis-à-vis available for sale (AFS), something which banks across the globe opt as normal risk management practice. Instruments held under HTM are not subject to mark to market.
What caused the debacle was that much of the HTM was deployed into mortgage-backed securities and when interest rates started increasing, the unrealised losses from these investments notionally shot up to $16 billion by September 2022.
As against the equity base of over $11 billion that quarter, the losses technically drove the bank to insolvency during the the September 2022 quarter itself. Adding to the intensity of ALM risks, depositors continued with their withdrawal spree, something that the US had not seen in decades.
In December, the SVB revealed its plans to sell part of its AFS portfolio and raise capital. While the former went through and helped garner $21 billion, Silvergate Capital’s voluntary insolvency announcement on March 9, made it impossible for SVB to tap the market and the run on the bank became inevitable. When more depositors started withdrawing money, all at once, the bank had to start selling some of its assets to give money back to depositors.
Since interest rates and yields are inversely related, the bonds bought earlier started quoting at low rates in secondary market. That means when interest rates go up, bond prices go down. Moody’s immediately downgraded SVB’s rating from A3 to Baa1 with negative outlook. It triggered further nervousness and the SVB stock fell by 60 per cent.
Finally, the California regulators ordered closure of SVB and appointed Federal Deposit Insurance Corporation (FIDC) as receiver.
Likely risks in Indian banks
Though the SVB debacle highlights the need to manage ALM risks better with a focus on liability management, the mix of ALM is more diversified in most banks in India. Banks in India have massive retail base with better propensity to deploy funds in loan assets. Therefore, the proportion of loans in the assets of Indian banks, at about 57 per cent (₹122.08 trillion out of ₹216.67 trillion) in March 2022, far exceeded that of SVB at 35 per cent ($74 billion out of $212 billion). SVB was more exposed to market risk.
Moreover, the investment portfolio is tightly regulated in India to distribute investment portfolio into held for trading (HFT), available for sale (AFS) and held to maturity (HTM) category. The short-term surplus funds are usually deposited with the RBI in fixed rate reverse repo and now in Standing Deposit Facility (SDF).
Long-term deposit resources are usually channelised to create loan assets after meeting statutory pre-emptions of the RBI. With the kind of diversity that the banking system is exposed to, the chances of similar risks are remote.
But when it comes to managing risks, banks have to remain alert towards the interconnectedness of the economy and spill over risks from external sector.
It is time banks in India reviewed their ALM policies and took a cue from SVB debacle to add more rigour to their risk management practices. Each risk incident anywhere in the globe should be closely analysed to insulate our banks from their consequences.
The writer is Adjunct Professor, Institute of Insurance and Risk Management. Views expressed are personal
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