Banking crisis: should you be worried about investing in this sector?

The biggest US bank collapse in a decade has rocked investor confidence

If a week can be a long time in politics, in financial markets it can make investors feel as though their whole world has been turned upside down.

For years, analysts have consistently peddled the line that higher – or at least rising – interest rates are positive for banks because it means they can generate a bigger margin on their lending.

Instead, last week’s collapse of Silicon Valley Bank has shown that rising interest rates have a negative effect on the value of bonds, which in turn can impact a bank’s liquidity, especially if its deposits don’t match its loans.

Investors have panicked, leading to a sharp decline in share prices around the world, with banking one of the worst hit sectors. While markets in Europe had started to calm down as of Tuesday 14 March, there remain two unanswered questions – are more banks going to get into trouble and will the SVB incident prompt central banks to be less aggressive with interest rate hikes? We don’t know the answer to the former, but the latter looks plausible.

WHAT HAPPENED TO SVB?

SVB was a specialist lender with a focus on technology and venture capital companies. At the end of last year, the bank had assets including loans of around $210 billion and customer deposits of around $175 billion.

There are two reasons why SVB got into difficulty, both of which centre on the mismatch between its assets and its deposits. First, the bank had fewer deposits than loans, so to finance some of its investments it had to borrow money at progressively higher rates, just as Northern Rock had to borrow from the UK interbank market, which proved its undoing. Second, the bank was taking in short-term deposits and investing them

By Ian Conway Companies Editor

in long-term assets like loans to companies and US government bonds.

Due to the popularity of venture-capital investing the bank’s deposits exploded from $60 billion to almost $200 billion in a short space of time, and it decided to invest a large chunk of this money in US government bonds when yields were very low. However, last year’s sharp rise in interest rates drove down the value of the bonds held by SVB and every other bank.

When customers started asking SVB for their money back last week, the bank had to sell some of its long-term bond holdings at a loss to raise the cash to meet the withdrawals. Once the market got wind SVB might be in trouble there was a fullblown ‘run’ on the bank, leading to a collapse in its share price.

Californian state regulators took over the bank and the US Treasury, the Federal Reserve and the Federal Deposit Insurance Corporation stepped in to guarantee all of SVB’s deposits and protect its customers.

COULD MORE BANKS BE IN TROUBLE?

As well as guaranteeing SVB’s depositors that their money was safe, in a re-run of measures introduced in the great financial crisis of 2008 US regulators agreed to let banks use the Federal Reserve’s ‘discount window’ to borrow cheaply to finance customer withdrawals if they needed to.

Despite the improvement in banks’ capital ratios since 2008, investors still have concerns over the ability of some US specialist and regional lenders to meet customer withdrawals so shares of First Republic Bank (FRC:NYSE) and Western Alliance (WAL:NYSE) slumped after the SVB debacle.

In the UK, shares of the big high-street banks Barclays (BARC), HSBC (HSBA), Lloyds (LLOY) and

NatWest (NWG) have also been under pressure and by the evening of 13 March the FTSE 350 bank index had lost close to 10% of its value in a week.

Shares of smaller, less heavily capitalised firms such as Bank of Georgia (BGEO), TBC Bank (TBCG) and Virgin Money (VMUK), which rely on the stability of their deposit base, also fell on the stock market although there is no indication that any of them have any operational difficulties.

Ratings agency Moody’s believes the decline in bond values is temporary and most European banks have enough liquidity to meet any potential liability, allowing them to hold their bonds to maturity.

WHY DID HSBC BUY SVB’S UK OPERATIONS?

HSBC paid £1 to rescue the UK arm of SVB and protect its depositors. The company said the acquisition would strengthen its commercial banking arm and enhance its ability to serve ‘innovative and fast-growing firms’, including in the technology and life-science sectors.

The Bank of England said the deal would ensure ‘the continuity of banking services, minimising disruption to the UK technology sector and supporting confidence in the financial system’.

It also stressed no other UK banks were materially affected by the failure of SVB and the wider UK banking system was ‘safe, sound and well capitalised’.

WHAT DOES IT ALL MEAN FOR START-UPS?

The immediate effect of the turmoil at SVB is likely to be that banks and other financial firms tighten