We have only to establish the fact that the return to monetary stability does not generate a crisis. It only brings to light the malinvestments and other mistakes that were made under the hallucination of the illusory prosperity created by the easy money. People become aware of the faults committed and, no longer blinded by the phantom of cheap credit, begin to readjust their activities to the real state of the supply of material factors of production. It is this—certainly painful, but unavoidable—readjustment that constitutes the depression—Ludwig von Mises
In this issue
US Banking Crisis: Will Philippine Banks be Immune from a Contagion?
I. US Banking Crisis: The Silicon Valley Bank Run Pulled the Rug Under the Prescribed Banking Benchmarks!
II. US Banking Crisis: The Bailout and its Immediate Impact; the Periphery to the Core Process
III. US Banking Crisis: Will the Philippines be Immune from a Contagion?
IV. The Corrosion of Bank Liquidity and Slowing Pace of Deposit Growth
V. Three Reasons Behind the Faltering Bank Cash Reserves
VI. Concentration Risk: Real Estate as the Biggest Bank Borrowers, as Universal Commercial Banks Takes Command of the Financial System
VII. Summary
US Banking Crisis: Will Philippine Banks be Immune from a Contagion?
I. US Banking Crisis: The Silicon Valley Bank Run Pulled the Rug Under the Prescribed Banking Benchmarks!
GMA News, March 15, 203: Finance Secretary Benjamin Diokno on Wednesday said the Philippine economy is spared from the potential impact of the collapse of Silicon Valley Bank (SVB) in the United States. “[The] Philippine economy [is] unaffected by SVB collapse,” Diokno said in a Viber group message to reporters.
Allow me to open with a quote from the dean of the Austrian school of economics, the great Murray Rothbard.
But in what sense is a bank “sound” when one whisper of doom, one faltering of public confidence, should quickly bring the bank down? In what other industry does a mere rumor or hint of doubt swiftly bring down a mighty and seemingly solid firm? What is there about banking that public confidence should play such a decisive and overwhelmingly important role?
The answer lies in the nature of our banking system, in the fact that both commercial banks and thrift banks (mutual-savings and savings-and-loan) have been systematically engaging in fractional-reserve banking: that is, they have far less cash on hand than there are demand claims to cash outstanding. (Rothbard, 2016)
In gist: Borrowing short and lending long leads to liquidity concerns that render the modern banking system vulnerable to bank runs.
This dynamic demonstrates that liquidity, backed by confidence/trust, is the raison d'etre incumbent in the banking system. Conversely, a dearth of confidence/trust may spur problematic liquidity dimensions that could fuel bank runs.
Liquidity issues are usually products of solvency conditions but not necessarily.
That said, it is natural for authorities to publicly downplay risks, given the sensitivity of the banking system to changes in liquidity and confidence/trust.
And not only do the central banks act as lenders of last resort, but their other technical role is to provide liquidity insurance to banks and, thus, the economy. (Tucker, 2014)
If there has been anything new, social media has played a crucial role in recent bank runs.
Unlike in the past, when people lined up outside the banks for withdrawals, the run in Silicon Valley Bank (SVB) had partly been triggered by network effects (some big tech names asked their connections to withdraw from SVB) and Twitter—the bank run took place in less than 48 hours!
But there seems hardly a realization that three US banks collapsed within six days of March 2023! Six days.
Silvergate Bank announced its voluntary liquidation on March 8th. Authorities closed Silicon Valley Bank (SVB) and Signature Bank on March 10th and 12th, respectively. SVB was the 16th largest bank in the US.
But the most important fact was that SVB came as a surprise to authorities and mainstream institutions alike.
Figure 1
The mainstream's banking dashboard didn't exhibit any alarm bells: as the bank run occurred, credit rating agencies even rated SVB as investment grade! (Since its shutdown, the company erased the ratings.) (Figure 1, uppermost table)
Moody's threatened to downgrade SVB on March 8th. It lowered its rating to "negative" on March 10th, as the bank folded!
The Visual capitalist has a nifty chart exhibiting the timeline of the SVB collapse, accessible here.
Nevertheless, citing the swift downgrade of First Republic as signifying a panicked reaction of credit rating agencies, analyst Wolf Richter wrote: (bold added)
This comes after the fiasco of SVB Financial, which was rated comfortably inside investment grade by S&P Global and Moody’s until March 10, the day it collapsed, when Moody’s slashed its ratings by 13 notches in one fell-swoop to default, and S&P slashed its ratings by 10 notches to default. (Richter, 2023)
That SVB had banking metrics above required, the analysts of the Cato Institute likewise observed: (bold added)
The 2022 financials show similar ratios for SVB Financial Group, with a slightly higher leverage ratio of 8.11 percent and a slightly lower tier 1 capital ratio of 15.4 percent. (Silicon Valley Bank also reported similar ratios, both higher than in 2021, and both well above the minimum required.) … So, SVB Financial Group (and the commercial bank itself) had capital ratios approaching twice the minimum required, even after if crossed the $100 billion threshold. (Michel and Anthony, 2023)
The thing is, everyone was flying blind because SVB followed the prescribed banking benchmarks!
Chief Economist of Tressis, Daniel Lacalle pointedly wrote: (bold added)
SVB made one big mistake: Follow exactly the incentives created by loose monetary policy and regulation.
…
The entire asset base of SVB was one single bet: Low rates and quantitative easing for longer.
…
SVB showed how quickly the capital of a bank can dissolve in front of our eyes. (Lacalle, 2023)
Despite investments in "low-risk" or "high-quality" credit (US Treasuries and Federal Agency MBS), which were substantially tacked into held to maturity (not mark-to-market), soaring interest rates led to unrealized losses in the face of large and volatile uninsured deposits.
Concerned about the mounting losses, SBV's large depositors, mostly tech investors, pulled out. Social media fueled a domino effect, which further vacuumed liquidity and left SBV near insolvency and unable to settle other obligations.
From a technical perspective, author Satyajit Das explained: (bold added)
SVB's collapse can be attributed to familiar and avoidable banking risks -- asset-liability mismatches and concentration risk.
All financial intermediation involves maturity transformation. Banks take short-term deposits but invest these funds in longer-term loans or securities. This makes them vulnerable to a rapid loss of deposits which exposes them to the liquidity and price risk of realising assets. Abnormal concentration of depositors or borrowers creates exposure to the withdrawal of funding or default on assets or investments with resulting liquidity or solvency issues. (Das, 2023)
In short, the establishment also glossed over the lethal cocktail mix of concentration risk and Balance Sheet mismatch.
Before the banking crisis surfaced, in a speech last February, Martin Gruenberg, the FDIC Chairman presciently warned of unrealized losses in the banking system, (bold added) (Figure 1, middle chart)
This chart shows the elevated level of unrealized losses on investment securities due to high market interest rates. Unrealized losses on available–for–sale and held–to–maturity securities totaled $620 billion in the fourth quarter, down $69.5 billion from the prior quarter, due in part to lower mortgage rates. The combination of a high level of longer–term asset maturities and a moderate decline in total deposits underscores the risk that these unrealized losses could become actual losses should banks need to sell securities to meet liquidity needs. (Gruenberg, 2023)
Long story short, the composition of deposits (funding) and asset mix (operations) matter.
Aside from ballooning balance sheet mismatches, reduced bank competition in the face of skyrocketing assets from Fed policies has magnified concentration risks in the US banking industry. (Figure 1, lowest chart)
II. US Banking Crisis: The Bailout and its Immediate Impact; the Periphery to the Core Process
Nonetheless, the US Fed bailed out the banking industry and its depositors. It created the Bank Term Funding Program (BTFP), an emergency lending program providing loans of up to one year to financial institutions that pledged high-quality collateral—valued at par instead of mark-to-market—allowing them to borrow unimpaired by the losses from rate hikes.
Essentially, it broke its rule of providing a guaranteed limit of USD 250,000 per depositor. Instead, it signaled a 'blanket guarantee' for uninsured deposits of the industry, which are mainly accounts of the wealthy. US banks have above $9.2 trillion in uninsured deposits.
And with the Fed absorbing devalued collateral, this interest rate subsidy effectively transfers risk from bondholders to the taxpayers. It also signaled that the FED could backstop the losses of the banking system.
Worst, the rescue promotes a moral hazard, which could magnify the industry's risking taking activities since they expect authorities to safeguard their interests at the expense of the public. It should also intensify imbalances in the financial system and the economy magnifying their fragilities.
As it happened, the massive rescue reversed the decline of the Fed’s balance sheet, which soared by nearly USD 300 billion, while the Fed's discount window rocketed to All-time highs as banks availed of the Fed's support! (Figure 2, topmost and second to the highest window)
Panic was in the air.
Fleeing regional banks, depositors shifted into "too big to fail" banks, which were "implicitly" backstopped by the government. Also, about USD 120 billion of deposits stampeded into government-supported Money Market Funds in a week, resulting in the amassment of about USD 5 trillion of highly liquid/cash-like vehicles. (Figure 2, second to the lowest window)
The mounting differentials of lower deposit rates of small banks (perhaps due to excess reserves and competition) and higher money market fund rates may have prompted the search for higher yields. This deposit flight escalated to a point where it impaired the liquidity conditions of affected smaller banks. (Figure 2, lowest chart)
Lastly, as part of the feedback loop, panic at regional banks has also sent depositors scampering towards "implicitly" government-backed institutions or financial vehicles.
Yet, JP Morgan estimates that the Fed may inject liquidity by as much as USD 2 trillion into the system!
In any case, it is path dependent or mechanical for central banks to respond to episodes of financial instability by bailing out or throwing money into the system. It did so during the UK LDI pension crisis, and again, in response to the March 2023 US banking crisis and likewise in last week’s turmoil in Credit Suisse.
In addition, eleven of the biggest US banks joined hands to rescue another troubled small bank, the First Republic Bank, by providing USD 30 billion. Naturally, this had implicit blessings from the Fed.
All this is very interesting.
Monetary authorities did not see this coming, yet they gamble on policies that result in the entrenchment of imbalances, which should lead to such cataclysmic outcomes. Diminishing returns also affect these policies.
Nonetheless, since 2020, we seem to be witnessing a developing financial crisis in motion, via the periphery to the core process: first, emerging/frontier market sovereign debt crisis (Zambia, Ghana, and Sri Lanka), then to UK’s pension crisis, then March 2023 US banking crisis and then Credit Suisse saga.
And the time window for the credit events to emerge appears to be narrowing.
In the end, if the crisis emerged by slipping past the radar of the US authorities and financial institutions, why should the public believe the assurances of the authorities?
In 2017, when the current Treasury secretary Ms. Janet Yellen was the US Federal Reserve Chair, she predicted that there would be "no crisis in our lifetimes."
And this applies to the local environment too.
III. US Banking Crisis: Will the Philippines be Immune from a Contagion?
Should developments in the US serve as a roadmap elsewhere, including the Philippines?
Again FDIC’s Mr. Gruenberg, from a speech two days before the voluntary liquidation of Silvergate Bank and four days prior to the shutdown of SVB, (bold added)
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. (Gruenberg, 2023)
Remember, because SVB's financial metrics seemed healthy in the banking system's dashboard, it failed to spot the abrupt emergence of the crisis.
And so, using the above template, we shall focus on the liquidity, assets, and concentration risks of the domestic banking system.
This article aims to provide updates on the health of the banking system.
And it is up to the reader to discern the validity of the assurances made by the authorities.
How significant are the balance sheet mismatches of the banking system? Well, a lot.
The BSP admitted to this in 2019 in their 2018 Financial Stability Report, which incidentally operated on an environment of falling CPI and interest rates. (bold original, italics mine)
The build up of leverage creates mismatch risks in the banking books. While financial authorities look at the CGDP ratio and the CGDP gap to get a holistic view of the standing of credit vis-Ã -vis the economy, banks get a similar—though own-view—perspective from its loan-to-deposit ratio (LDR). As expected, this has trended upwards (Figures 2.11) near to levels that would theoretically represent the upper bound as a result of the reserve requirement.
The rising LDR suggests that the maturity mismatch is likewise increasing. Funds sourced by banks are largely savings deposits which are then used to fund longer-term credits. As Figure 2.12 shows, this creates a gap between the amount of assets and the corresponding amount of deposits categorized by maturity. With the average maturity of loans calculated at 4.25 years (Figure 2.13), the maturity gap then translates into a liquidity gap as well. Banks would, therefore, not only provide for the difference between the tenor of what they lent versus the short-term deposits that they borrowed but they will also have to provide liquidity for the periodic withdrawals of those deposits. (FSCC, 2019)
And much has happened between then and now.
And this perspective provides a clue why the BSP embarked on a series of cuts in the Reserve Requirement Ratios (RRR) of Banks in 2018-2019 from 19% to 14%.
IV. The Corrosion of Bank Liquidity and Slowing Pace of Deposit Growth
How liquid is the banking and financial system?
Figure 3
The two principal liquidity gauges of the BSP, cash-to-deposit and liquid assets-to-deposit, have been headed downhill since 2013. (Figure 3, upmost chart)
Cash-to-deposit last January was at its lowest level since at least 2013.
After its May 2021 pinnacle, liquid assets-to-deposit seem to have turned the corner and resumed its southbound path.
Despite the recent injections by the BSP, cash reserves have been dropping. Cash reserves have been in deflation since December 2021. (Figure 3 middle chart)
And much of the cash levels of banks have resonated with BSP QE operations (net claims on central government), which demonstrates the critical role dispensed by the BSP. (Figure 3, lowest pane)
Figure 4
And despite the recent upsurge in bank lending, the growth of deposit liabilities continues to slow. The total deposit liabilities grew 7.7% last January, primarily from FX deposits (which could have emanated from FX borrowings of the Bureau of Treasury, while some may have signified conversions from peso accounts). (Figure 4, topmost chart)
And depositors have barely been lured by rising rates. (Figure 4, middle pane)
Peso deposits grew by 6.53% in January, powered mainly by Time Deposits, which grew by 30.4%. Time deposits accounted for 21% of the Peso deposits.
Curiously, savings deposits have barely been growing. Following the spike from the BSP injections last December, it was up by a measly .1% this January. Peso savings even suffered two months of deflation in October and November.
The thing is, though deposits continue to grow, it has been substantially slowing.
And neither cash reserves (which depend on the BSP activities) nor deposit liabilities have exhibited strength.
V. Three Reasons Behind the Faltering Bank Cash Reserves
And why have the stock and the delta or rate of change of cash reserves been declining?
The first factor is credit delinquency.
Non-Performing Loans (NPL) gnaw at cash or vacuum away liquidity.
Thanks to the various relief measures, which helped the banking industry look better statistically, NPLs have improved despite rising rates. However, NPLs rebounded last January.
Interestingly, loan provisions have diverged from NPLs since the 2H of 2021, possibly indicating repercussions from such relief measures. The BSP decreed an extension of such measures until June 2023. (Figure 4, lowest window)
The next factor is the tightening policy of the BSP.
Such activities cover not only rate hikes but also financing operations of deficit spending activities of the National Government.
After the monster December deficit funded by the release of government deposits in the same month, the BSP reversed much of its operations this January as fiscal activities turned into a surplus from a sharp decline in public spending. (Prudent Investor, 2023)
The "Held-to-Maturity" segment of financial assets of the banking system represents the last factor.
The following excerpt comes from the BSP-led FSCC's 2017 Financial Stability Report.
Banks face marked-to-market (MtM) losses from rising interest rates. Higher market rates affect trading since existing holders of tradable securities are taking MtM losses as a result. While some banks have resorted to reclassifying their available-for-sale (AFS) securities into held-to-maturity (HTM), some PHP845.8 billion in AFS (as of end-March 2018) are still subject to MtMlosses (Figure 3.8). Furthermore, the shift to HTM would take away market liquidity since these securities could no longer be traded prior to their maturity (FSCC, 2018)
It has been crystal clear that the rising rates have substantially affected bank holdings of Philippine Treasuries.
Figure 5
First, banks have also been part of liquidity operations in collaboration with the BSP.
Hence, a critical factor in the bank accumulation of Treasury securities has been the surge of net claims on the central government (NCoG). (Figure 5, topmost chart)
Rising rates appear to have backfired on bank holdings of these "safe" assets.
Yet, in the context of the peso, the NCoG of banks has been slightly off the record highs, while HTMs carved a new high last January.
Because banks have sustained their accumulation of treasuries, the financial assets continue to outgrow the loan portfolio.
Next, since financial assets represent 96% of the total investments, its winning streak has eroded the share of cash and the total loan portfolio. (Figure 5, second to the highest pane)
As of January 2023, the investment pie rose to a 29.2% share of the total assets of the banking industry, up from 21.42% in June 2020 or signifying a 36.3% growth.
The latest 'recovery' in banking loans has arrested its declining share.
The bank lending pie remains a slight majority—52.3% in January—of the overall bank assets.
And because bank investments recently reached record highs, rising rates affected mark-to-market (non-HTM) securities, which led to record losses last October. (Figure 5, second to the lowest window)
And thanks to the falling yields and partly due to BSP operations, such losses have been pared down to Php 86.1 billion in January 2023 from Php 122.85 billion last December and Php 146.06 billion last October.
Finally, as noted by the BSP, the drain in liquidity, as measured by cash-to-deposit, appears to mirror the incredible surge in HTMs. (Figure 5, lowest chart)
HTMs have become a substantial segment of bank balance sheets.
As of January, it accounts for 17.4% of total assets and 22.7% of deposit liabilities.
VI. Concentration Risk: Real Estate as the Biggest Bank Borrowers, as Universal Commercial Banks Takes Command of the Financial System
Let us move on to concentration risk.
Despite the sharp drop in the % share of real estate loans, the sector remains the biggest borrower. (Figure 6, topmost chart)
Figure 6
As of January 2023, the sector's share of total bank loans accounted for 19.6% as consumer loans outsprinted bank lending growth.
Yet, total bank loans slipped to Php 2.25 trillion in January 2023 from the landmark high of Php 2.3 trillion last December.
The real estate sector remains the largest borrower despite its declining contribution to the GDP. (Figure 6, second to the highest chart)
Further, although the pie of Universal and commercial bank of the total financial resources dipped to 77.5% in January from the milestone of 77.8% last December, it remains the principal driving force of the financial resources. (Figure 6, second to the lowest chart)
Meanwhile, due to Universal and commercial banks, the banking industry has shanghaied an 82.52% share of the total resources, a tad lower than the historic 82.9% last December.
Finally, as a % share of total bank assets, total capital accounts bounced by 12.31% last January from 11.74% in December.
Despite the relief measures, which muddies the real health conditions of banks, the Total Capital Accounts share of total assets has been on a cascade since 2019. It's been on a downtrend since 2013.
A decline of more than 13% of the asset base could be enough to wipe out the capital account.
As noted above, the "SVB showed how quickly the capital of a bank can dissolve in front of our eyes."
VII. Summary
In summary, we find the following facts.
Bank liquidity, dependent on the BSP, continues to erode.
Deposits, the cheapest source of bank financing, continue to grow but at a slower pace.
The forces affecting bank liquidity have been the following:
One, rising NPLs consume liquidity.
Two, to combat inflation, the BSP has implemented liquidity-tightening policies.
And last, a record surge in HTM assets has locked out accessible liquidity to the industry.
Regarding concentration risk, the real estate sector remains the largest client of banks.
Led by UCs, banks continue to shanghai a larger share of financial resources.
The Total Capital Accounts share of total assets has been on a cascade since 2019.
How "sound" is the domestic banking sector given the SVB template?
_____
References
Rothbard Murray N. Anatomy of a Bank Run, March 7, 2016, Mises.org
Tucker, Paul, The lender of last resort and modern central banking: principles and reconstruction, Working Papers p.12, 2014 Bank for International Settlements
Richter, Wolf; First Republic Downgraded by S&P from Confidence-Inspiring-LOL “A-” Investment-Grade to BB+, One Itty-Bitty Notch into Junk. Shares, Bonds Re-plunge, Wolfstreet.com, March 15, 2023
Michel, Norbert and Anthony, Nicholas Dodd Frank Was Never Gutted – It Was Barely Touched, Cato Blog March 14, 2023
Lacalle, Daniel; Silicon Valley Bank Followed Exactly What Regulation Recommended, March 12, 2023
Satjayit Das, The Unwinding: Will collapse of $200-billion Silicon Valley Bank trigger major contagion event? March 13, 2023, New India Express
Gruenberg, MartinRemarks by FDIC Chairman Martin Gruenberg on the Fourth Quarter 2022 Quarterly Banking Profile, February 28, 2023 FDIC.gov
Prudent Investor, The BSP Unveils Stealth QE 2.0 (Variant)! January 15, 2023, Substack, blogger
Gruenberg, Martin: Remarks by FDIC Chairman Martin Gruenberg at the Institute of International Bankers, March 6, 2023 FDIC.gov
FINANCIAL STABILITY COORDINATION COUNCIL 2018 H1–2019 H1 FINANCIAL STABILITY REPORT, p.15-16, September 2019 Bangko Sentral ng Pilipinas
FINANCIAL STABILITY COORDINATION COUNCIL, 2017 FINANCIAL STABILITY REPORT p.24, June 2018, Bangko Sentral ng Pilipinas, Bangko Sentral ng Pilipinas
