21st March 2023

Allianz Trade reports on the Silicon Valley BankSVB) collapse

Allianz Trade comments:

"The SVB failure was caused by poor risk management choices but also highlights banks’ general macro-financial challenges from restrictive monetary policy, which essentially removes diversification. Negative returns from bonds and equity put pressure on assets while quantitative tightening has led to a contraction of money supply, resulting in greater competition for deposits(as banks lend less).

Essentially, SVB was the epitome of wrong-way risk–it accepted very lumpy deposits from start-ups(which parked their venture capital funding), used related-party equity in these start-ups to collateralize loans and invested excess funds in mostly long-dated mortgage-backed securities at a time when the yield curve was inverting even more, squeezing their net interest margin. As much as central banks’ fast rate hikes to tackle inflation hit the bank’s asset side (resulting in unrealized losses that exceeded their capital base) they also caused an economic pinch for their start-up depositors, who started withdrawing their funds long before the deposit run that brought SVB to its knees.
-In the wake of SVB’s failure, banks will become even more conservative in their lending. The planned resolution of the SVB imposes direct cost of other US banks, which will foot the bill for making all depositors whole(though higher FDIC fees) but, more critically; there is also an indirect effect of rising moral hazard in the banking sector as the Federal Reserve seems to be willing to still backstop failing banks. Over the near term, financing conditions are bound to tighten further in the US economy(and other countries) as banks raise lending standards and carefully safeguard their liquidity positions, further retrenching credit."

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