interest rate risk
A bank is exposed to interest rate risk when rates move rapidly within a short period of time. This is exactly what has happened in America since March 2022. The Federal Reserve is raising rates aggressively. 4.5 percentage points so far, so as to control rising inflation, as a result of which interest recovery on loans has increased at a proportionate rate. The interest yield on one-year US government Treasury notes reached a 17-year high of 5.25% in March 2023, down from less than 0.5% in early 2022. The yield on the 30-year Treasury has climbed nearly 2 percentage points. As the yield on a security increases, its value tends to decrease. And so such a sharp rise in rates in such a short period of time has led to a delinquency of previously issued debt – whether corporate bonds or government treasury bills – especially long-term debt.
For example, a 2 percentage point gain in the 30-year bond yield can reduce its market value by about 32%. A substantial 55% of the Silicon Valley bank’s own assets were invested in fixed-income securities, such as US government bonds. Of course, interest rate risk due to a decline in the market price of a security is not a major problem, as long as the owner holds onto it until maturity, at which point he can collect his original face value without realizing any loss. . Unrealized losses remain hidden in the bank’s balance sheet and disappear over time.
But if the owner has to sell the security before its maturity at a time when the market price is less than the face value, the unrealized loss becomes a realized loss. That’s exactly what SVB had to do earlier this year as its customers began withdrawing their deposits to deal with their own cash crunch – while even higher interest rates were expected. This brings us to liquidity risk.
Liquidity risk is the risk that a bank may not be able to meet its obligations when they are due without loss. For example, if you use $150,000 of your savings to buy a house and in the meantime you need some or all of that money to meet another emergency, you may experience the consequences of liquidity risk. are doing. A major chunk of your money is now stuck at home, which cannot be easily converted into cash.
SVB’s customers were withdrawing their deposits beyond what they could pay using their cash reserves, and so to help meet their obligations the bank liquidated $21 billion of its securities portfolio at a loss of $1.8 billion. decided to sell. The outflow of equity capital prompted the lender to attempt to raise more than $2 billion in new capital.
The call to raise equity shocked SVB’s customers, who were losing faith in the bank and rushed to withdraw cash. A bank run like this can make even a healthy bank bankrupt in a matter of days, especially in today’s digital age. Partly this is because many of SVB’s customers had deposits of more than $250,000 insured by the Federal Deposit Insurance Corp.—and so they knew their money would not be safe if the bank collapsed. Roughly 88% of deposits in SVBs were uninsured. Signature faced a similar problem, as the collapse of SVB prompted many of its customers to withdraw their deposits out of similar concerns over liquidity risk. About 90% of its deposits were uninsured.
All banks today face interest rate risk on some of their holdings due to the Fed’s rate-hiking campaign. This has resulted in a loss of $620 billion on bank balance sheets by December 2022. But most banks are unlikely to have significant liquidity risk. While SVB and Signature were complying with regulatory requirements, their asset composition was not in line with the industry average.
More than 5% of Signature’s assets were in cash and SVB held 7%, compared to the industry average of 13%. In addition, SVB’s 55% of its assets in fixed-income securities compare to the industry average of 24%. The US government’s decision to backstop all deposits of SVB and Signature, regardless of their size, should reduce the likelihood that banks with less cash and more securities on their books will suddenly suffer a liquidity crunch due to mass withdrawals from panic. Will face shortage. However, with more than a trillion dollars in bank deposits currently uninsured, I believe the banking crisis is far from over.
: Language Inputs
This post is sourced from newspapers, magazines and third-party websites. For more information please check NewsDay Express Disclaimer.