U.S. Banking Turmoil: From A European Perspective

What Exactly Happened to SVB?

To begin building an understanding into the key threat facing U.S. and EU banking institutions, let’s analyze what exactly led to Silicon Valley Bank’s (SIVB) demise.

SVB was a key lender in the silicon valley area. Many of the most prominent tech companies based in the valley used the bank to hold cash for payroll and other such business expenses. This led to a huge surge in deposits at the bank which was great news for the institution.

As most banks do, SVB invested a significant portion of these deposits. SVB invested a significant portion of this capital into long-dated US government bonds, including those backed by mortgages.

Traditionally these bonds are incredibly secure and low-beta financial instruments which therefore make them a fantastic pick for financial institutions such as banks. The issue arises from the relationship these bonds have with interest rates.

Government bonds hold an inverse relationship rule with interest rates; when rates rise, the price of these bonds will decrease.

While these bonds have been a great choice over the last decade thanks to the loose and expansionary monetary policy pursued by the fed, the post-pandemic economic boom meant inflation began to run rampant.

To control this, the Fed began a series of interest rate hikes designed to curb fiscal spending and thus, reduce the inflationary pressures present within the economy.

Because of this, many bond holders – including institutions such as SVB – found themselves with portfolios which were (and continue to be) losing value by the minute.

To ensure enough capital remained to payoff any immediate withdrawals, SVB announced a $1.75B capital raising to offset the sale of loss-making bonds.

Compounding this situation, the general bear markets currently being experienced across the stock market meant many of SVB’s customers (many of whom are institutional organizations with huge accounts) began drawing upon their deposits to fund their own business operations.

This led to what essentially culminated as a good old-fashioned bank run. A sudden realization that the bank was short of capital led to mass-withdrawals. Ultimately, SVB failed to have enough capital on hand to deal with the huge number of withdrawals thus causing the collapse.

The entire event took just 48 hours between the first disclosure of SVB selling some of their bonds and the banks ultimate demise.

Many have implied that the U.S. government is stepping in to save SVB: this is not the case. While U.S. agencies have guaranteed to cover all deposits at the bank, SVB as a company will remain collapsed with any remaining assets most likely being dispersed to creditors.

Current Situation In The U.S.

Many investors have found themselves in a sea of informative articles analyzing the effects the sudden collapse of Silicon Valley Bank along with Signature Bank will have on the U.S. economy. However, a key question that should be asked is how immune are other domestic banks to the same fate?

The truth is, the U.S. is facing a banking crisis. President Biden has reassured citizens that their finances are in safe hands, but I believe this overarching statement is little more than a simple publicity attempt to ease the concerns of the general population.

While most other banks do not face the same set of unfortunate circumstances and portfolio of clients that combined to cause SVB to fail, the threat of contagion has grown significantly over the past week.

Many economists fear the regional US banks face a real risk of customers withdrawing their deposits and savings in an effort to increase their own perceived levels of financial security.

This could lead to many regional banks collapsing much in the same manner as SVB with some banks such as First Republic Bank (FRC) based in San Francisco seeing their share prices drop by a whopping 80%.

EU vs U.S. Key Differences

Clearly, the U.S. banking sector is seeing a significant uptick in negative sentiment and systemic risk. Threat of contagion is very real and has caused a level of uncertainty not seen last since the financial crisis and subsequent collapse of banks such as Lehman Brothers in 2008.

The shockwaves sent by the collapse of SVB could even be felt across the pond in Europe with many huge banking names such as Credit Suisse (CS), HSBC (HSBC) and AIB seeing their share prices plummet by up to 12%.

While most of these European banking stocks have seen their valuations return through small rallies, the question must be asked whether these international banks face the same set of threats as their U.S. counterparts.

As a result of the U.S. crisis, there will most likely be an increased rate of withdrawals across the globe than banks would have been expecting. Luckily for EU banks, significant supranational regulations and increased capital reserves should mean European banks won’t face the same liquidity crisis as their domestic counterparts.

In the Eurozone, banks must have a loan-to-deposit ratio of 86%. This means for every €100 deposited into the bank, €86 must be kept as excess cash.

EU banks also tend to utilize significantly less leverage than their U.S. counterparts which further helps to increase stability in the sector and avoid a liquidity crisis situation as some U.S. institutions have seen.

Even still, some European banks such as Credit Suisse have revealed the true extent of their financial troubles. Such poor management and negative market sentiment could begin spreading fast across the European and Asian markets which absolutely places the global banking systems at risk.

European banks also feature significantly more diversified funding structures with around 40% of funding coming from retail deposits. The failed SVB had a retail deposit funding ratio of just around 7%.

Fundamentally, European banks should be more protected against collapse than their U.S. counterparts. The recent stock rallies and continued strength of most EU banks is welcomed news for many investors and customers alike. However, there is a key difference between EU banks and European banks.

The Credit Suisse Situation

Credit Suisse is a global investment bank and financial services firm founded and based in Switzerland. Following the collapse of SVB, it emerged that the Credit Suisse was significantly more unstable financially than previously believed.

Credit Suisse has for long been considered a problem child bank in Europe experiencing a significant sell-off which began in 2021, caused by the collapse of investment funds Archegos and Greensill Capital.

Compounding this, rumors in late 2022 of the bank facing an impending failure led to over 110B Swiss francs being withdrawn by clients in Q4 FY22. The bank simultaneously suffered a 7.29 billion franc annual loss.

While the Swiss central bank provided Credit Suisse with a $54B lifeline to ensure liquidity at the bank, ultimately this seems to not have been enough for the stricken bank.

UBS (UBS), another Swiss bank has agreed to buy Credit Suisse for just €3B. This move comes after recommendations by the Swiss Central Bank for the takeover to happen and is the culmination of a tumultuous journey for the bank.

While this takeover ultimately means increased liquidity for Credit Suisse as well as some consolation to its clients, the quick downfall of the global bank should act as a warning sign to all investors. While Eurozone banks seem more protected than their non-euro counterparts, even these banks are not immune.

Summary

An unstable banking system spearheaded by the collapse of key banks suggests consumer sentiment and trust in the economy achieving a soft-landing have soured. I believe the significant uncertainty now surrounding banks across the globe significantly increase the threat of a recession.

While EU banks could potentially offer investors more stability in the coming months, and their recent slips following the news of the Credit Suisse sale provide some attractive prices, significant risk could still be present.

The single biggest threat lies in the potential for contagion with falling levels of consumer confidence in banks leading to bank runs and liquidity collapses. U.S. banks have seen a similar slip in valuations following the Credit Suisse takeover which suggests the negative market sentiment is global.

I will be closely analyzing European banks over the coming weeks to decipher which institutions could offer investors the greatest level of stability.