Money Guide | basic banking risks
Also: Indicators, World Watch, Weekly Agenda, News, Musings, Opportunities
Money Guide is a personal project, supported by paid-subscriptions. I hope that all readers find the news timely and relevant, the musings interesting, the opportunities attractive, and my thoughts enriching and provoking.
In this issue: Multiple banks collapsing, Recession looming, Interest rate hikes, Inflation watch, Debt Ceiling, Luxury Watches, Australian batteries, Greek ratings, Indian manufacturing, and a few thoughts on basic banking risks
Indicators
Previous update: March 5th, 2023
🟢=positive mid-term forecast*
🔴=negative mid-term forecast*
⚪=neutral mid-term forecast*
🟩=positive past-period performance
🟥=negative past-period performance
⬜=neutral past-period performance
▲=increase during past-period
▼=decrease during past-period
─=no change during past-period
Click here for an in-depth look at how to read the Money Guide Indicators
🔒🟩▼ US Inflation: 6.40% (vs 6.50% 12/22)
🔒🟥▲ US Funds Rate: 4.75% (vs 4.50% 11/22)
🔒🟩▼ US 02Y T-Note: 4.50% (vs 4.75%)
🔒🟩▼ US 10Y T-Note: 3.70% (vs 3.96%)
🔒🟥▲ DXY index: 104.63 (+0.1% vs 104.53)
🔒🟩▲ EURUSD: 1.07 (+0.9% vs 1.06)
🔒🟩▼ EU Inflation: 8.50% (vs 8.60% 01/23)
🔒🟥▲ EU Funds Rate: 2.50% (vs 2.00% 11/22)
🔒🟥▲ USDMXN: 18.40 (+2.5% vs 17.95)
🔒🟩▼ MX Inflation: 7.60% (vs 7.91% 01/23)
🔒🟥▲ MX Funds Rate:11.00%(vs10.50% 11/22)
🔒🟩▼ MX 01Y Cetes: 12.07% (vs 12.09%)
🔒🟥▼ DJIA: 33374 (-0.2% vs 33425)
🔒🟥▼ S&P500: 3876 (-4.2% vs 4045)
🔒🟥▼ NDQ100: 11946 (-3.2% vs 12344)
🔒🟥▼ RUT: 1807 (-6.3% vs 1928)
🔒🟩▼ GSCI: 576.00 (-3.3% vs 595.85)
🔒🟩▼ Brent Oil: 83.47 (-4.2% vs 87.14)
🔒🟥▲ Gold: 1867 (+0.6% vs 1855)
🔒🟥▼ BTC: 22216 (-1.0% vs 22432)
🔒🟩▲ ETH: 1591 (+1.7% vs 1564)
🔒|🟥 Overall
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World Watch
🔒⬜ International conflicts (Ukraine, US vs China, Middle East, East Asia)
🔒🟩 Local conflicts (US, Latin America, Europe, China)
🔒🟩 International Trade and Commodities (Shortages, chain disruptions)
🔒🟩 Bond markets (Liquidity, Participants, Volatility)
🔒⬜ Corporate health (Q42022 reports, 2023 forecasts)
For more:
2023 Threats
2023 Threats’ status updates
Weekly Agenda
All times are US ET (GMT-5)
Monday, February 6th
10:00 🔒 US Consumer Inflation Expectations report
Tuesday, February 7th
07:30 🔒 US Consumer Price Index (CPI) report ⚠️
(Previous: *, Expected: *)
Wednesday, February 8th
07:30 🔒 US Producer Price Index (PPI) report ⚠️
(Previous: *, Expected: *)
07:30 🔒 US Retail Sales report
(Previous: *, Expected: *)
Thursday, February 9th
08:15 🔒 EU ECB Interest Rate Decision
(Previous: *, Expected: *)
Friday, February 10th
09:00 🔒 US Consumer Sentiment report
(Previous: *, Expected: *)
⚠️Probable high volatility when information is released to the public
(Click here to read about the usual market behavior)
*Forecasts, analysis and additional information in the previous sections are available only in the premium edition of Money Guide for paid-subscribers
News
📰 🔴 How does a bank collapse in 48 hours? A timeline of the SVB fall | This week, the go-to bank for US tech startups came rapidly unglued, leaving its high-powered customers and investors in limbo. (link)
📰 🔴 Regulators close Crypto-focused Signature Bank, citing systemic risk | U.S. regulators on Sunday shut down New York-based Signature Bank in a bid to prevent the spreading banking crisis. (link)
📰 🔴 Silvergate shutting down operations, liquidating after Crypto meltdown | It has served as one of two main banks for the crypto industry, along with Signature Bank. The firm reported a nearly $1 billion dollar net loss in the fourth quarter following a rush for the exits at the end of last year that saw customer deposits plummet 68% to $3.8 billion. To cover the withdrawals, Silvergate had to sell $5.2 billion dollars of debt securities (link)
📰 🟢 US regulators say SVB customers will be made whole as second bank fails | The FDIC will make SVB and Signature’s customers whole. By guaranteeing all deposits -even the uninsured money that customers kept with the failed banks- the government aimed to prevent more bank runs and to help companies that deposited large sums with the banks to continue to make payroll and fund their operations (link)
📰 🔴 Recession risk looms large as Bond markets price in steeper rate hikes globally | The bond market is now pricing in a steeper path for monetary tightening by central banks around the world, raising the danger of recessions as policymakers struggle to bring inflation under control (link)
📰 🔴 Deepest Bond Yield inversion since Volcker suggests hard landing | In general, such inversions preceded economic downturns by 12 to 18 months. The odds of another occurrence are intensifying after Powell’s comments indicate he is open to reverting to half-point rate hikes in response to resilient economic data (link)
📰 ⚪ Fast-money quants are buying stocks as human traders stay put | The divergent positioning highlights something of a tug of war in the equity market between technical and fundamental forces. On the one hand, momentum and volatility signals have pushed investors like to keep buying stocks, adding fuel to the upside. On the other, the new year rally that lifted the S&P 500 as much as 17% from its October low is seen by many as a bear-market trap (link)
📰 🔴 Crypto companies behind Tether used falsified documents and shell companies to get bank accounts | In late 2018, the companies behind the most widely traded cryptocurrency were struggling to maintain their access to the global banking system (link)
Musings
💭 🔴 Remarks by FDIC Chairman Martin Gruenberg at the Institute of International Bankers | “The current interest rate environment has had dramatic effects on the profitability and risk profile of banks’ funding and investment strategies. First, as a result of the higher interest rates, longer term maturity assets acquired by banks when interest rates were lower are now worth less than their face values. The result is that most banks have some amount of unrealized losses on securities. The total of these unrealized losses, including securities that are available for sale or held to maturity, was about $620 billion at yearend 2022. Unrealized losses on securities have meaningfully reduced the reported equity capital of the banking industry” (link)
💭 🔴 Wall Street braces for the next Silicon Valley Bank | Shares of regional banks tumble amid concern that SVB’s collapse is only the beginning. First Republic clocked their worst week on record. Citizens Financial Group Inc, Comerica Inc, Fifth Third Bancorp, Zions Bancorp and Charles Schwab Corp each shed more than 15% last week (link)
💭 🔴 The cost of food is down, but grocery bills are still up. Here's why | When food producers started raising prices a few years ago, they blamed their own costs, including higher ingredient prices. But ingredient prices have actually been on a downswing for months, and individuals are still paying more for food (link)
💭 🔴 Jerome Powell says US Fed is likely to speed up interest rate hikes if the economy keeps roaring | Federal Reserve Chairman Jerome Powell told lawmakers Tuesday that policymakers may have to speed up their interest rate hikes to tame high inflation (link)
💭 🔴 The Debt Ceiling Is the Risk Wall Street Doesn’t Want to Think About | The consequences of the government defaulting on its bills are so terrible that investors just assume a deal will happen (link)
Opportunities
💡 Investment in Rolex, Patek watches exceeds S&P gains over five years | Prices for luxury timepieces such as Rolex, Patek Philippe and Audemars Piguet appreciated by an average of 20% a year since mid-2018. Over a longer period, stocks outperformed watches as an investment asset. The S&P 500 had a compound annual growth rate of 12% between 2012 and 2022, while Rolex, Patek and AP watches averaged 7% (link)
💡 End of coal power in Australia is spurring a battery bonanza | The country has at least 250 planned battery developments with a potential capacity of almost 130,000 megawatt-hours, a pipeline that’s second only to China (link)
💡 Greece months away from investment-grade rating, says Central Bank chief | Greece is close to regaining its investment-grade credit rating in 2023, after 12 years of relegation to junk status (link)
💡 Apple to shake up international sales operations to make India its own region | In addition to serving as a sales engine for Apple, India is also becoming more critical to the company’s product development (link)
💡 Rookie traders are earning $400,000 in one unlikely markets hub | Elite recruits with math and science backgrounds can command up to that amount (link)
A few thoughts on…
basic banking risks
In the same week, Silvergate Bank (SI), Signature Bank (SBNY) and Silicon Valley Bank (SIVB) have collapsed. They have (had?) a few things in common:
They chose names that start with “Si”
They had customers mainly from Tech/Startup/Crypto sectors
They invested most of the funds on long-term “safe” instruments
They suffered bank-runs
All (or most of us) know the simple model of a banking business:
Take deposits (borrow) from customers. This is sometimes referred to as “borrowing short”, because the bank is borrowing from customers that might demand back their funds on a short-term period without prior warning.
These deposits are liabilities for the bank. The bank owes the customers’ funds and the interest rates they offer in exchange for themGive credit (lend) to customers. This is sometimes referred to as “lending long”, because the bank is lending to customers that will pay back their credits over long-term period.
These credits are assets for the bank. The bank owns the customers’ loans and the interest rates they charge in exchange for them
Usually, banks earn more from the interests they charge than from the interests they pay, and that spread is their profit. Of course, there other banking activities, and there are other assets and liabilities, but these two are the basic ones we need to have a grasp on how they work.
During the course of human history, banks have found ways to increase their profits. At first, by charging higher interest rates on loans, but competition between banks tends to drive interest rates down. However, higher-risk credits are worth higher interest rates and banks sometimes chased these opportunities, but financial crises (like the Great Financial Crisis of 2007-2008) contributed to regulations that reduced some of the relative risks that banks can take and their capital requirements.
As a result of those regulations, banks are encouraged to invest their funds on assets perceived as safe, and the safest kind of assets are Government Bonds. Instead of only lending to individuals or corporations through credit cards, mortgages, revolving lines of credit, and other types of financing, banks lend a large part of their funds to local or national governments that are less likely to default on their obligations.
Before this cycle of hiking rates began on 2022, interest rates were close to zero. This contributed to economic growth through lots of available funds to invest in companies and lots of cheap credits (and this turned into a cycle). Banks received lots of deposits and needed to invest those funds to earn profits. Since interest rates were very low, they turned to longer term loans to increase their profits. Under normal circumstances, longer-term loans pay higher interest rates, to compensate the lenders for the increased risk they are assuming.
But there is a problem that arises when Central Banks hike interest rates.
Bonds prices go down as interest rates go up, and viceversa.
Imagine a bank is lending their customers’ funds to the US Government through 10-year Treasury Notes at a 1.5% annual interest rate. The bank doesn’t have cash, the bank now has US Treasury Notes. At this point, the bank is not insolvent because it has the assets (the US Treasury Notes) to cover the liabilities (the customers’ deposits). If one day later the bank’s customers ask for their funds back, the bank has a liquidity crunch because it doesn’t have cash and it can’t give the customers the Treasury Notes. The bank needs to sell the assets to pay for the liabilities. The bank can sell the Treasury Notes probably for the same price that it bought them (or close to it), pay the customers’ funds and everything is alright.
Now, imagine a similar scenario but, this time, a year has passed after the customers deposited their funds, interest rates are higher and Treasury Notes prices are lower. Why are they lower? If the bank tries to sell $100 of Treasury Notes that pay $1.50 every year when the interest rate for those same notes has gone up to 4%, it will have to sell it a discount: the $100 with a 1.5% interest rate are worth now roughly the same as $78 with a 4% interest rate. At this point, the bank is technically insolvent because it has assets (the US Treasury Notes) that cannot cover the liabilities (the customers’ deposits). This is a Mark-to-Market loss on their books (it is still an unrealized loss) and banks don’t have to account for that market loss yet -if the bank can hold those Treasury Notes to maturity, the bank would receive back the $100 plus interest and everything would be fine. However, if the bank’s customers ask for their funds back, the bank wouldn’t just have a liquidity crunch but also be insolvent because it doesn’t have cash, it can’t give the customers the Treasury Notes and the Treasury Notes cannot cover the customers’ deposits. When the bank sells those Treasury Notes, the unrealized losses become realized losses.
That is how an accounting problem becomes a real problem.
Silvergate Bank, Silicon Valley Bank and Signature Bank catered to a lot of Tech/Startup/Crypto companies that received a lot of funds on previous years, and invested most of those funds on long-term sovereign bonds and similar instruments with low-interest rates.
When the economy was humming and interest rates were low, those bonds could be held to maturity and interest payments were enough to turn a profit and cover few customers’ withdrawals, since Tech/Startup/Crypto companies had investor funds and didn’t need that much cash to cover their expenses.
When the economic reality changed and interest rates increased, Tech/Startup/Crypto companies desperately needed cash, these banks had to sell long-term bonds for lower prices, suddenly became insolvent, and a run-on-the-bank ensued when customers noticed and demanded their funds in a panic. The banks went bankrupt through a self-fulfilling prophecy. The banks could have stayed afloat if customers had remained calm and kept their deposits for a longer term. The banks became insolvent even though they had invested on “safe” assets that were considered “low-risk”.
When we talk about the 2007-2008 Great Financial Crisis many terms come to mind: “Derivatives”, “Sub-Prime”, “Collateralised Debt Obligations“ (CDOs), “Credit Default Swaps” (CDS). Maybe this time everyone will get familiarized with “Concentrated risks”, “Interest-rate risks”, “Mark-to-Market losses”, “Bank-runs” and some other ones.
This panic by Tech/Startup/Crypto triggered by economic tightening might turn out to be the first examples of something bigger. Other banks (and their customers) are already afraid of similar runs. As the FDIC Chairman observed, this situation is generalized over the entire banking sector.
And, lest we forget, who else has customers concentrated on a specific sector, has most of its assets on “low-risk” interest-paying instruments, and acts like a bank? Tether, the issuer of Crypto Stablecoins. But they say their assets are mainly short-term instruments, so we shouldn’t have reasons to panic. However, they also have a colorful history of less-than-ideal honesty and transparency. If Tether is hiding something now, they better fix it fast before it’s too late.
take care, have fun, be chill
-SM
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