Silicon Valley Bank’s demise represents a worst case scenario of the dangers that lie in wait for banks all over the world, due to the discrepancy between the term structures of their assets and liabilities.
A bank borrows short term and lends long term and when higher interest rates combine with clients drawing down on their deposits, a run on the bank is always a looming threat. Silicon Valley Bank had two additional risks in the form of high exposure to tech start-ups and excessive investments in US Treasury bonds.
When interest rates in the US were near zero, many banks swelled their asset base with low-risk and long-dated bonds. The Federal Reserve in the US is now counting the cost of its over-zealous switch to a hawkish monetary policy stance, which led to an increase in the cost of capital of 85% over the past year. When bond yields rise, as they did, the value of this asset class declines.
Higher interest rates also caused the market for initial public offerings by many start-ups to take a huge dip, leading to a spike in withdrawals by clients of Silicon Valley Bank, in order to shore up their liquidity. The bank was then forced to sell a portfolio of bonds at a loss of $1.8 billion and, as an inference, to attempt raising capital of $2.25 billion in equities.
Key venture capital firms then reportedly advised companies to withdraw their deposits from the bank, causing a run which literally destroyed its market capitalisation within hours and necessitated a take-over by the US bank regulator.
Unfortunately, the problems at Silicon Valley Bank were not confined to the US, with Switzerland’s second largest bank, Credit Suisse, being taken over by the country’s largest bank, UBS, following the intervention of the country’s central bank.
Are South Africa’s banks safe?
The question now arises whether South African banks will be able to weather the new storm in the world’s financial markets. Fortunately, the answer is positive, as the country has a well-established and effective banking regulatory framework.
One measure of the financial stability of banks that includes comparisons between key emerging markets was discussed in the latest Global Financial Stability Report, published by the International Monetary Fund (IMF), namely changes in the volatility regimes related to expected default frequency (EDF).
This is measured as the number of days with a relatively high level of such volatility, covering the period 2006 to 2020. Based on the average annual days when banks experienced some risk associated with EDF, South Africa compares quite well, coming in at 20% below the average for the 15 countries included in the study.
In an assessment conducted after the 2009 financial crisis by the IMF, it was concluded that banking supervision in South Africa was effective, which made it possible to escape any significant impact arising from the global recession that accompanied the crisis.
Throughout the crisis, South Africa’s banks had remained profitable and capital adequacy ratios were maintained well above the regulatory minimum. The IMF commended the Bank Supervision Department of the South African Reserve Bank for its early adoption and full implementation of the Basel II framework.
The Basel accords represent a set of financial reforms developed by the Basel Committee on Banking Supervision (BCBS), with the aim of strengthening regulation, supervision, and risk management within the banking industry.
The BCBS was established in 1974 by the central bank governors of the Group of Ten (G10) countries, as a response to disruptions in financial markets. The committee was expanded in 2009 to 27 jurisdictions, including South Africa. Essentially, the accords aim to prevent banks from hurting the economy by taking more risks than they can handle.
Judging by the latest round of financial reporting by South African banks, it is clear that profitability and stability have returned to pre-Covid levels. It seems, therefore, that clients of local banks have nothing to fear and, at current prices and dividend yields, shares in JSE-listed banks are an attractive proposition for investors.