5 min read I Date: 14 March 2023
The failure of Silicon Valley Bank (SVB) has raised concerns about potential banking crises. It is, however, important to note the United States (U.S.) banking system is highly complex, with around 4,700 banks operating under various charters and (overlapping) regulations.
Despite this complexity, failures are not as common as expected, with only eight banks failing between 2018-2020. In the period of 2008-2012 (Global Financial Crisis), 465 banks failed with total assets of approximately US$700 billion.
The recent administration order on SVB last Friday is the first such failure since 2021, with total assets of approximately US$200 billion. Effective regulation and risk management are crucial in the U.S. banking industry.
What are the Fed’s responses? 2
The Federal Reserve (Fed) has announced steps on 12 March 2023 [SDaS1][SNARN2]to make funding available to banks to cushion any potential risk prompted by Friday's failure of SVB. The aim is to protect the U.S. economy by strengthening public confidence in the banking system through these actions.
- The government will provide full access to deposits for customers of SVB to prevent contagion at other small and regional banks owing to SVB’s sudden failure.
- The rescue plan involves tapping a deep reserve of bank-funded federal insurance money, not taxpayer dollars, according to officials.
- The Federal Deposit Insurance Corporation (FDIC) will reimburse all depositors of SVB, not just those whose balances are within the $250,000 guaranteed limit. The FDIC is equivalent to Malaysia’s PIDM.
- The Fed also introduced a new Bank Term Funding Program - a lending facility which will provide additional funding to banks that run into liquidity problems. Essentially, the program offers banks loans of up to one year, taking government-backed bonds as collateral, and valuing those bonds at face value rather than marking them to market.
- The government will not provide any relief to the equity and bondholders of SVB, as they took a risk as owners of those securities and will take the losses.
The Fed will likely need to put extra focus on the financial stability side of its mandate, taking consideration of the additional pressures a rate hike could put on the financial system. While a rate hike pause could result in a loosening of financial conditions, it would likely be offset by the inevitable tightening in bank lending standards, greater risk aversion, and (now that there is a greater appreciation of the financial stability risks of higher rates) higher rate sensitivity of risk assets. As a result, pausing in March may actually not set the Fed back in its inflation fight.
Once the immediate financial stability concerns have passed, it will be important for the Fed to restart rate hikes.
As such, investors should prepare for only a temporary pause in rate hikes, with a peak Fed funds rate of 5.25%-5.5% likely. The risks to this forecast are unusually elevated and further deterioration in the health of the financial system will inevitably reduce the peak rate forecasts.
The Facts 3
The failure of SVB is certainly a cause for concern, however there are several arguments against the idea that it could be the start of a wider crisis.
- Firstly, SVB's unique business model, which focused on a narrow tech corridor, increased concentration risk, and left the bank unable to handle the flood of deposits that came in as the tech industry flourished during the pandemic period (2020-22). The bank is unfortunately caught in a pincer movement between rising deposit withdrawals and the need to convert held-to-maturity to available-for-sale securities, forcing SVB to recognise investment losses.1
- This situation developed when SVB is unable to lend out the deposits received. U.S. companies were generally reluctant to take on more loans given the raising interest rate environment. To generate a return on the excess deposits management bought into long-terms bonds, e.g., US Treasuries through the 2020-22 period. This led to a mismatch of assets and liabilities which exaggerated the situation.1
In summary, while there are certainly risks in the U.S. banking system, the current situation does not appear to be systemic. The big four banks are likely to benefit from a rising tide of deposits, and smaller banks that may be equally exposed to narrow niches (e.g., tech, digital assets) while mismatching assets and liabilities should be able to learn from the mistakes of SVB.1
In the latest development, Hong Kong and Shanghai Banking Corporation (HSBC) announced it will buy the UK subsidiary of the U.S. based SVB. The move coupled with the Fed’s backstop measures would help to calm fears of investors.4
- The recent market sell-off, particularly in the U.S. financial sector, has raised concerns among the investors to their portfolios. However, we are confident that our funds are well-positioned to weather these fluctuations.
- Our investment process is rigorous and designed to ensure that we only hold the best quality stocks including banking stocks. These helps to minimise the impact of market volatility on our portfolio. The development in SVB is viewed as a standalone event that can be attributed to their large exposure to startup tech companies and should not be viewed as an implication of the broader U.S. or global financial sector.
- We acknowledge the potential risks in the current market environment will be an area of concern to investors. We are confident in our investment strategy and are committed to delivering long-term value to our investors. In addition, we will continue to closely monitor market developments and adjust when necessary.
Investment strategy to navigate the current landscape5
- In the wake of the recent global uncertainties and the continued volatility in the market, investors can consider focussing on income to weather these uncertain times. One area that investors may want to consider is the fixed income space, particularly in Malaysia.
- Despite the current market environment, Malaysia's fixed income assets offer attractive yields within the investment grade space. This can provide a steady source of income for investors and potentially help to mitigate losses from equity investments.
- Additionally, income-generating investments can provide a cushion against inflation. As inflation rates rise, the income generated by these investments can also increase, helping to protect against the eroding value of money.
- Our fixed income investment strategy continues to lean towards high quality corporate credit, as we believe that it offers better returns and is less prone to market volatility. In terms of duration, we intend to focus on medium duration and would gradually be expanding the duration band as we identify opportunities in the market. This approach will enable us to strike a balance between achieving higher returns and managing risks associated with longer duration investments.
- On equity, given the diverging economic indicators and market conditions, we believe that a more regionally selective approach will be beneficial to our investment strategy. We will maintain our broad investment approach, with a continued emphasis on quality growth, income, and sustainability, as these attributes remain essential in achieving long-term investment success.
You are advised to read and understand the relevant Prospectus, Information Memorandum and/or Disclosure Document including any supplemental thereof and the Product Highlight Sheet (if any) before Investing. Among others, you should consider the fees and charges involved. The registration of the relevant Prospectus, Information Memorandum and/or Disclosure Document including any supplemental thereof and the Product Highlight Sheet (if any) with the Securities Commission Malaysia (SC) does not amount to nor indicate that the SC recommends or endorses the funds. A copy of the relevant Prospectus, Information Memorandum and/or Disclosure Document including any supplemental thereof and the Product Highlight Sheet (if any) may be obtained at our offices, distributors or our website at www.principal.com.my. The issuance of any units to which the relevant Prospectus, Information Memorandum and/or Disclosure Document relates will only be made on receipt of an application referred to in and accompanying a copy of the relevant Prospectus, Information Memorandum and/or Disclosure Document. Please be advised that investment in the relevant unit trust funds, wholesale funds and/ or private retirement scheme carry risk. An outline of the various risk involved are described in the relevant Prospectus, Information Memorandum and/or Disclosure Document. As an investor you should make your own risk assessment and seek professional advice, where necessary. Securities Commission Malaysia does not review advertisements produced by Principal.
- Bloomberg, Macquarie Research, Principal compilation as of 13 March 2023.
- Bloomberg, FDIC, PGAA, Principal compilation as of 13 March 2023.
- Macquarie Research, Bloomberg, Principal compilation as of 13 March 2023.
- Bloomberg, Principal compilation as of 13 March 2023.
- Principal View as of 13 March 2023.