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How the collapse of a small bank hit markets around the world

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Bank shares in the US and Europe came under strong pressure

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Bank shares in the US and Europe came under heavy pressure as liquidity problems at a small US bank, Silicon Valley Bank, which finances start-ups, raised concerns about the sector as a whole. A negative conjuncture made up of disparate factors has transferred the crisis from a small US bank, which finances start-up companies, to the wider US banking industry and, as of yesterday, even to European banks, and has led to a concerted decline in bank stocks.

According to a report by Kathimerini, it is on the one hand the hardship faced by the start-up technology companies in the previous months and on the other hand the losses caused to the banks last year by the drop in bond prices amid interest rate increases. These two factors caused a liquidity crisis in the small American bank Silicon Valley Bank (SVB), whose actions, however, raised concerns among investors. Thus, Europe's banking share price index posted its worst session since June yesterday, with German giant Deutsche Bank down more than 8% and Societe Generale, HSBC, ING Groep and Commerzbank recording losses of more than 5%.

Facing losses in its portfolio due to the distress of startups and the consequent reduction in its deposits, Silicon Valley Bank was forced to sell shares worth $21 billion to raise capital and cover the significant losses in its portfolio. The news, however, caused the immediate reaction of some investors, such as Founders Fund, Coatue Management and Union Square Ventures, who hurried to reduce their exposure and withdraw their funds from the wintering bank. This was followed by the free fall of SVB's stock, which lost 60% of its value in Thursday's session, while the value of its bonds also fell significantly.

But the shocks that have spread throughout the banking industry and sent the banks into decline are due at least in part to a coincidence: the fact that SVB's crisis happened to coincide with that of Silvergate Capital Corp, resulting in the two parallel banking crises to inspire concern among investors and drag down at least 5% the shares of the largest US banks, such as Bank of America, Wells Fargo, Citigroup and Jpmorgan Chase. These four big banks lost a combined $52.4 billion in market value, while the global KBW Bank Index fell more than 7%, the most since June 2020.

Investors' concerns

Investors began to worry about potential problems in the portfolios of other US banks, and in particular about the risks posed by their extensive bond holdings. This is because during the pandemic and the lockdowns, many of the big banks accumulated an unusually large amount of deposits and placed them in long-term US government bonds. The value of these bonds, however, fell significantly over the past year due to the large increase in interest rates. After all, a few days ago, data from the Federal Deposit Insurance Authority was made public, showing that American banks have losses in the order of 620 billion dollars in their portfolios.

Meanwhile, the downside coincided with a fall in bank deposits as savers sought higher yields as the US Federal Reserve continued to raise interest rates. As industry analysts point out, the worst-case scenario that banks may face from now on would be to be forced to follow SVB's example and, in order to cover the reduction in their deposits, sell bonds at reduced prices and record losses.

According to Christopher Whalen of Whalen Global Advisors, this is not going to harm the solvency of most financial systems. “The problem will mainly be faced by those banks that have a very large exposure to US government bonds,” he emphasizes and concludes: “They were caught sleeping, nobody expected such a prolonged high inflation”, an inflation that would dictate such large interest rate increases. Similarly, economist and investor Mohamed El Erian believes that the risk from SVB can be easily limited with careful management, as the US banking system is strong as a whole, even if the same is not true of each bank individually.

However, not everyone shares his optimism. Nick Wilson, chief analyst at Markets.com, is concerned that the developments at SVB could be the fuse that blows up banks amid risks from rising interest rates and a “fragile” economy of the USA. And for James Athy, chief investment officer at Abrdn, “the problem in the system is the levels of leverage.” As he explains, “monetary policy has been extremely expansionary and facilitated leverage for far too long”.

Source: www.kathimerini.com.cy

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