SVB: LCR not used effectively?
SVB Shutdown:
LCR report not effecively used?
Story So far: From the news
reports, Silicon Valley Bank (SVB) was the 16th largest Bank on the date of its shutdown by the
regulator. Its assets included mortgage backed securities (MBS), which is
said to have increased from a level of USD 12 billion in 2019 to USD 90 billion in 2021. Due to the increase of fed fund rates by more than 400
bps last year, the average yield in MBS increased to 5% plus, with a
consequential fall in the value of MBS. (the price and yield on bonds are
inversely proportional). When the demand from the depositors for
withdrawal/redemption mounted, mainly start-ups, the bank had to sell MBS
valued at USD 21 billion by booking a loss of USD 1.8 billion. With the
sequence of events that followed shortly, the regulator shut down the bank's
operations and appointed FIDC (Federal Deposit Insurance Corp) as
receiver.
Strange indeed: Interestingly,
the bank reportedly failed, not due to bad loans or toxic investments, but due
to negative mismatch in ALM (demand far exceeding sources in the relevant
buckets).
LCR GUIDELINES: In this regard,
after introduction of Basel III guidelines, SVB is the first major bank to fail
across the world. To prevent a run on the bank in the short term and to ensure
proper monitoring by the regulator, liquidity coverage ratio (LCR)*, as
stipulated under Basel III, is one of the important monitoring tool
that is in vogue in majority of the countries, more so in USA. As
per the guidelines, investments in sovereign and non-sovereign are allowed to
be included under HQLA (High Quality Liquid Assets that can be converted into
cash without loss of time) against which net cash outflows for the next 30 days
are compared to arrive at the LCR (The ratio should be a minimum of 100%).
While government securities and the like are included under level 1 assets,
relatively more but moderate risks come under level 2A and 2B assets.
Residential MBS is included under level 2B assets (of HQLA) with caveats such
as - they are subjected to 25% haircut and that the total of level 2B assets,
including RMBS cannot be more than 15% of level 1 assets.
LCR report not revealed or not used effectively?: If the
newspaper reports are true, most of the assets of SVB were parked in MBS.
Reasonably assuming that they represent Residential MBS and taking into account
the current market value, hair cut and maximum cap stipulations for level 2B
assets, the total amount of MBS that would have been eligible to be
shown under level 2 assets for HQLA calculations must have been far less
compared to the total outstanding in that portfolio. Since SVB had MBS as
its major asset portfolio, the size of HQLA, in all probability, would have
been less than net cash outflows and LCR also would have been less than
1. This should have been the case for a long time. The question that
arises in my mind is if the LCR conveyed short-term resilience concerns, what
supervisory remedial actions were initiated by the bank or the regulator. I
just want to remind the readers that when Yes Bank in India was put under a
reconstruction plan by RBI in March 2020, the LCR reported under Basel III
guidelines was 40% (as against regulatory stipulation of 100%) and the decline
was perceptible as compared to the previous two quarters (74.61% in Dec 19 and
113.83% in Sep 19).
My views: There are other supervisory aspects
under Basel III guidelines, of course. But LCR and NFSR were insisted under
Basel III for monitoring short-term and long-term resilience and since this is
a case of ALM mismatch, LCR would have been the ideal tool that should have
been effectively used for supervisory monitoring and corrections.
Regards
V. Viswanathan
13th March 2023.
*The objective of
the LCR is to promote the short-term resilience of the liquidity risk
profile of banks. It does this by ensuring that banks have an adequate
stock of unencumbered high-quality liquid assets (HQLA) that can be
converted easily and immediately in private markets into cash to
meet their liquidity needs for a 30 calendar day liquidity stress scenario.
Sir,
ReplyDeleteThis is a concise and complete article which captures the story in a nutshell.
While there seems to have been no deliberate malafide intent on the part of the Bank, there certainly was a go-by given to safety norms. Things may have sailed through safely if the Fed had not raised its rates (which they had not done so drastically for decades). By so raising the rates, the Bank was served with a double whammy. On the one hand, it's asset yields came down even as deposit rates were going up, coupled with the fact that customers were withdrawing heavily to meet their working capital needs, as also to invest in other higher yielding avenues.
This looks like such a freak occurrence.
The lesson to be learnt by practicing Bankers is to meticulously follow guidelines to the dot.
Thankyou again for such superb articles.
Thank you very much for the kind words. I always valued your inputs, which reflect your rich experience and knowledge. Regards Viswanathan
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