There is a global banking crisis under way the likes of which we have not seen since the global financial crisis. Could it affect SA’s banks? In a word, “no”.
The issues plaguing US banks and Credit Suisse in Europe are unique. The US mid-tier banking system crisis is reminiscent of the small banks crisis in SA that raged in the early 2000s. There are two principle causes of the US crisis: an outdated accounting treatment for those banks’ portfolios of government bonds, and an astoundingly light-touch regulatory approach that exempted banks with less than $250bn in assets from the stress tests that would have revealed the problems. In SA this would never happen — banks’ portfolios of financial instruments are marked-to-market so pain is visible right away, a requirement of the accounting standard IFRS 13. And the Reserve Bank’s stress testing of interest rate risk is stringent and universal.
The collapse of Silicon Valley Bank (SVB) reflected one of the oldest risks in banking: it raised money from short-term deposits and invested it in long-term assets. This “maturity transformation” is an important economic function of banks. But when banks don’t manage the interest rate risk that arises, it can fell them. This was precisely the problem in SA’s small banks crisis when several banks used short-term deposits from fickle corporate customers to fund long-term loan books. When confidence began to fray following the dot.com bust and the legacy of the 1998 emerging markets crisis, the run on the banks could not be met with easy-to-access liquid assets. SVB has had the same problem.
A large part — 43% — of SVB’s assets were US government bonds. The bank had grown fast since the pandemic, nearly doubling deposits between 2021 and 2022. Banks can’t originate “normal” loans as quickly, so the easy option is to park this cash in government bonds. Because those were yielding nearly nothing at the shorter end, SVB put them into long-term government bonds. Such bonds are fixed-rate instruments, meaning the interest earned doesn’t change, even though bonds have 30 years or more until maturity. So when rates started rising in the US, deposits must be paid more interest, but the bank wasn’t earning any more on its portfolio of bonds.
Normally that would have been obvious to the market and the bank would have had to actively trade out of the exposure. But under US banking rules, a bank can park government bonds in a portfolio that is held to maturity, and value them at the face value of the bonds rather than current prices. This meant the bank didn’t have to register losses, and therefore didn’t have to do anything about them. It is clear on SVB’s statutory accounts that the gap between fair value and par value for its bond portfolio was widening and was at $15bn in its accounts for the year to end-2022, according to financial statements published on February 24, while total equity was just $16bn. The share price started to tank only two weeks after those numbers were released.
Interestingly, some of this resonates in SA. The banking system here has also seen a big spike in deposits since the Covid crisis, rising from R4.6-trillion to R5.4-trillion, or from 67% to 74% of assets. Similar to banks elsewhere, it has parked this extra cash in government bonds, which have risen from 7% to 11% of assets, a record. Longer-term bonds in SA have not seen the same level of pricing shift as in the US, so that portfolio has not registered anything like the losses. Also, banks are far more active in managing duration risk by ensuring the liability side of the balance sheet has longer term rates too, and by using derivatives like swaps. Banks must ensure they stick within liquidity and interest rate risk ratios, which they report on every month to the Reserve Bank. Risk is just much better managed here than the US.
The US mid-tier banking sector has seen share prices crash by a quarter. European banks are down about 16%, primarily due to Credit Suisse’s woes, though those are caused by a bad business model more than crazy interest rate risk management. Emerging markets banks are down only about 4% on the back of the chaos. SA banks are down about 8%, despite having just come out of a results season with record earnings.
In SA, the Reserve Bank has been actively concerned about the “bank-sovereign nexus” that arises when the sector is too exposed to government’s finances. Concern spiked early in the Covid period when the government’s debt trajectory was alarming. Since then, the government’s debt ratios have improved, so there is less concern. Banks, however, need a decent market recovery to start rebuilding their loan portfolios and diversifying their assets away from the sovereign. The SVB experience provides another reason to do so.