Bank failure

Sometimes spotting potential bank failures must be hard. One might think of really serious undiscovered fraud, or the weak controls that enabled a rogue trader such as Nick Leeson (who brought down Barings).

But if you were given the following set of facts about a bank:

  • very rapid growth over a short period
  • a heavy reliance on deposits withdrawable on demand,
  • perhaps especially a heavy reliance on uninsured deposits or similar funding,
  • a huge (and unusually large) share of the asset portfolio made up of long-term fixed rate bonds,
  • a position greatly expanded at a time when short and long term interest rates were at record lows.
  • no sign of any extensive use of interest rate risk hedging.

then even if you had reason to believe that the quality of the loans the bank had made were fine, the alarm bells should have been ringing very loudly.   It was a highly risky, nay reckless, way to run a bank.

That was, as I understand it, more or less the picture of SVB Bank, which was closed down by regulators on Friday.  If, like me, you’d never heard of SVB Bank a week ago, it doesn’t really matter.  It was a fairly big bank (second largest actual deposit-taking bank ever to fail in the US, even if small by the standards of JP Morgan or Bank of America) and it seems to have been boringly reckless.  Perhaps when the eventual book is written –  significant US bank failures usually prompt some author into print –  some good stories will emerge, but on the face of it (and there are dozens of articles over the weekend you can look up) the failure was depressingly vanilla in nature.  Chasing yield and coming a cropper,  Since the occasional headline-grabbing bank failure is a useful reminder of risk –  and that people, including very highly paid ones, make bad choices –  perhaps it is not even a bad thing that it happened (and deposits of up to $250000 each are covered by insurance).   Whether one goes that far or not, it is an episode that seems to reflect very poorly on the management and Board of SVB. but also on the bank’s regulators (in this case, primarily the Federal Reserve).    People, perhaps fairly, note limitations in the US regulatory system (and bank accounting standards), and the lobbying SVB Bank itself had engaged in to avoid being covered by some rules that apply (in the US) only to systemically significant banks.   But I am left wondering whether the relevant Fed examiners were asleep at the wheel.  After all, a smart and energetic young Fed analyst who’d never gone beyond publicly available information should have been able to look at the stylised facts above and yell “whoop, whoop, pull up”.    You might have hoped that when the CEO of SVB was (until Friday) on the board of the San Francisco Fed –  boards that from a policy perspective are more ornamental than substantive – that that alone would have meant a more than usual vigilance by Fed staff on risks associated with that bank.  But apparently not.

Anyway, my point wasn’t mainly to add to the oceans of SVB commentary, but to have a look at the big New Zealand banks.  They’ve been under fire lately, and they certainly do seem to be quite profitable businesses (although I’ve always been cautious about that view, including because the NZ subs are not charged for the (considerable) implicit parental support, without which their market funding costs would be higher) but for decades none of them has failed, or even come close.

There is, of course, an old line that part of the general way banks operate is to “borrow short and lend long”.  As the Governor put it in his speech a week or so back, hardly any bank in the world holds enough liquid assets that it could immediately meet all claims if they suddenly came due to today (even the ones that legally could be redeemed today).  Banks hold portfolios of liquid assets –  themselves voluntarily, and under regulatory duress – to limit liquidity risks, and when there is no question about the quality of a bank’s assets, banks also expect liquidity support (at a price) from central banks if they were to face unexpectedly intense liquidity pressures.  The fact that lender of last resort capability is known to exist is one reason why regulatory agencies need to impose liquidity requirements (otherwise holding more higher-yielding less-liquid assets will seem attractive to some bankers).

But bank runs (a) aren’t common, and (b) don’t typically strike out of the blue on innocent well-managed banks, so typically the much more important issue is around risks which threaten to impair a bank’s capital and undermine the prospect of depositors and other creditors being able to get all their money back when it falls due.  And the issue here is not so much what happens to measures of capital as regulators or accountants state them but about the underlying economic value.  Accountants and regulators may not require some assets –  some long-term bonds for example – to be marked to market, but whether the current market value of an asset is in the books or not does not change the facts of a potentially impaired market value.

SVB Bank seems to have been running massive and unhedged interest rate risk.  They had purchased huge volumes of long-term fixed bonds (mostly federal agency mortgage securities) and had, on the other side of their balance sheet, mostly short-term deposits repricing quite frequently.  You could hold a 30 year bond to maturity and know exactly what you will get back for it (assuming the issuer does not default) but it isn’t much comfort to you, or your creditors, if in the meantime your funding costs (deposit rates) have risen very sharply.   SVB seems to have been an extreme example even by US standards, but holding some, reasonably material, interest rate risk position doesn’t appear to be that uncommon in US banks, especially regional ones. 

But not in New Zealand.  Here is the market risk note in ANZ”s latest New Zealand disclosure statement.

ANZ disclosure

In the years shown ANZ took almost no active trading risk (first table) and even the second table (non-traded market risk) is very small for a bank its size.  That is all summarised in the final table.  A 5 percentage point parallel shift upwards in the interest rate yield curve looks as though it would make less than a 5 per cent difference to the bank’s net interest income.  About 6 per cent of ANZ’s capital is held to cover market risk.  

And here is the table summarising the time to reprice for both assets and liabilities

ANZ disclosure 2

On average, liabilities do reprice sooner than assets (check the “up to three months” column as an example) but note too the use of hedging instruments (primarily interest rate swaps): the bank seems to have had a lot of mortgages repricing between 1 and 2 years from balance date and not many liabilities repricing in the same period, but used swaps to substantially reduce the scale of the interest rate risks the bank was exposed to.  

I didn’t check all the other big banks –  although a quick look at ASB’s disclosure statement look very similar –  but I’d be surprised if there was anything very different in any of them.  It is the way banking is done in New Zealand (and a product of some mix of market, self and regulatory discipline).  Consistent with this, neither net interest margins nor returns on equity (with risks properly accounted for) are very sensitive at all to changes in the level of interest rates. 

But if you ever have money with a bank with the sorts of characteristics I listed at the start of this post –  and thus extremely exposed to any material change in the overall level of interest rates – you’d probably be well advised to get it out, very quickly.

But the other lesson from the events of the last few days is probably if you were counting on a public-spirited regulator to spot problems early and act decisively, well….at best that is quite a gamble too.  But if regulators can’t do better than what seems to have been on display in SVB you do wonder quite why we pay their salaries.

4 thoughts on “Bank failure

  1. Closer to home in NZ possible recession looks much like being driven int o depression.!
    By a Government that has no regard for controlling its fiscal policy or spending.
    Todays spending announcements are incredibly irresponsible for the stability of the NZ economy.Spending money they do not have
    This depression is already manifested in those businesses who suffered throughout the wringing out of inflation from NZ.
    The worst aspect is apparently politicians do not care so long as they get re- elected.
    Sorry about the rant ,but I do care,


  2. Michael, what are the segregations between the NZ branches and the Australian parents? I see the NZ arms are less leveraged than the parents but what does this really matter, if the Australian parent was in trouble then the NZ arm are not protected in any way are they?


    • The NZ subsidiaries have their own capital and boards and are required to have capability to operate standalone if something happened to the parent. How well it would all work in practice who knows (altho a common view was that in any case the Aus govt would put pressure on the nZ govt to participate in a joint rescue of the whole banking group). Several of the Aus banks also have NZ branches (for some wholesale and big corporate business) which are of course fully part of the Aus operation and mostly not subject to RBNZ supervision)


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