What Does the Silicon Valley Bank Have To Do With Us?

In March three medium sized U.S. banks got into trouble – Silicon Valley Bank (SVB), Signature Bank and First Republic Bank – sending financial ripples through the U.S. banking system and financial markets worldwide. These were followed by the overnight collapse of Credit Suisse, the 167 year old iconic Swiss bank. 

Fortunately the aforementioned banks were bailed out by their central banks through liquidation or shot gun marriages with stronger financial institutions. Unlike the 2008 crisis this one was quickly nipped in the bud and further failures should be contained.

There are some key take-aways from the U.S. mini crisis. One, unlike in 2008 when the collapse was due to bad mortgage credits, this one was precipitated by a liquidity crunch and failure by the banks’ management and regulators to spot the interest rate or duration risks on the bank balance sheets. The assets of SVB consisted mainly of excellent quality U.S. Treasuries and Mortgage Backed Securities (MBS). The problem was these were long duration securities whose value plummeted when interest rates rose. In SVB’s case the markdown was $1.8 billion which pretty much wiped out the bank’s capital. SVB was funding long term assets with short term deposits.

Two, the deposits of the three U.S. banks were chunky with many exceeding the FDIC insurable deposit of $500,000 so it did not take many depositors to flee to create a run on the banks. The Fed regulators failed to spot the risks in concentrated deposits particularly when coupled with the banks’ asset/liability mismatch.

Three, because the assets of the failed U.S. banks were below $250 billion, the banks were not subjected to the Fed’s stress test conducted on the bigger money center banks like JP Morgan, Bank of America and Citigroup. The stress tests are supposed to signal risks under various credit, market, duration, and interest rate scenarios.

Four, unlike years ago when bank runs would unfold over several days and even weeks, this one occurred literally within hours. SVB and Credit Suisse lost $40 billion and $10 billion respectively in deposits in one day alone. The chunkiness of the deposits was a factor in the rapid flight of money but with social media, the speed of information and easy mobile transfers, bank runs can happen even before management and regulators have time to step in. In the case of Credit Suisse all it took were two words from the Chairman of its biggest shareholder the Saudi National Bank (“Absolutely not” when asked if they would inject more money into CS) to cause panic withdrawals.

Five, unlike in 2008, the large private banks helped the FDIC contain the problem. A consortium of banks led by JP Morgan immediately deposited $30 billion into the First Republic Bank to shore up the latter’s liquidity and show the market they had confidence in the institution. UBS with the prodding of the Swiss National Bank salvaged Credit Swiss under duress preventing what looked to be a messy situation.

Six, the crisis highlighted the role of smaller regional and community banks in financing small businesses and commercial real estate. The fall of SVB & Co. will lead to a contraction of credit in these sectors and slow the economy deterring the Fed from further raising interest rates aggressively.

What is the impact of this last U.S. bank crisis on the Philippines?

The answer is almost none partly because by and large Philippine banks are strong and partly because the worldwide contagion was quickly snuffed by the rapid actions of the regulators. When they occur Philippine bank failures have been mostly among our rural and small development banks which are under-supervised.

However the U.S. crisis has some lessons for us:

One, it highlights the dangers of contagion and systemic risk in an economy. It is therefore relevant that Congress is poised to legislate the Maharlika Investment Fund which by its size, unconstrained mandate and lack of effective governance and accountability poses an existential danger to our economy and our banking system. When fully formed, the Fund will be larger than the Bangko Sentral, the PDIC, the Landbank and the DBP together. Should the Fund fail there is no lender of last resort big enough to contain the fall out. It will be a bunch of sailboats trying to rescue an aircraft carrier.

Two, the U.S. and Swiss crisis emphasized the importance of a robust central bank. Yet the Makarlika Fund is defanging the BSP by channeling funds originally allocated for the BSP’s capital; into a Fund that is left to its own economic and political devises.

Three, high interest rates have unintended consequences. We need to review the efficacy of raising the cost of money to contain inflation. The BSP just hiked its benchmark rate to 6.25% with Gov. Philip Medalla intimating that further hikes are in the offing. Despite over 400 basis points increase in interest rates in the last year prices continue to be elevated (when in other countries they are falling) suggesting our inflation is not principally due to excessive demand and liquidity but to factors like corruption and cartels in our food supply chain and housing shortages. In the meantime the escalating interest rates are hurting businesses and consumers slowing our economic recovery. Perhaps the BSP should consider options other than interest rates like decreasing the money supply through quantitative tightening where the collateral damage is more distributed and delayed.

Four, the BSP and the Treasury need the private sector in the event of a major Philippine financial crisis. The Government alone is unlikely to cope with a catastrophe given its limited fiscal space and borrowing capacity. Speaking of the latter despite DOF Sec. Diokno’s assurances that our sovereign debt is manageable and will organically decline with economic growth, our borrowings increased by almost a trillion pesos to P14 trillion in the last year even with a 6% GDP growth. 

Five, we need to examine the P500,000 limit on insured deposits. The latter is over 20 years old and has not kept up with inflation and the economy. It is equivalent to 2% of the U.S. limit of $500,000. The premium for the PDIC insurance is paid by the banking industry which will be the first to oppose any rise in the premium rate even as it will be the first to run to the PDIC when things get hairy.

Six, it is time to reassess the Philippine bank model. Banks are a unique industry in that, protected by a franchise, they are allowed to leverage themselves 10-15 times their capital mainly through deposits. This leverage has resulted in banks having some of the highest return on investment to shareholders compared to other businesses; while neglecting their role as intermediaries to the credit starved small businesses and agriculture. 

The U.S. crisis highlighted the role of regional banks in supporting small businesses. In the Philippines banks openly discourage small depositors for being unprofitable. Small accounts are charged disproportionate fees for deposits, foreign exchange and remittances. Recently my bank (which is among the top tier) offered to pay me 1.75% p.a. on a dollar time deposit even when others were offering 4-5%. When challenged, the bank agreed to double the rate. This example of banks taking advantage of unsuspecting depositors and borrowers is not unusual and they should be called out on it. Regulators and legislators should prescribe equal opportunity rules for small bank clients.

The growing distrust of bankers has spawned fintech settlement systems like GCash and PayMaya in the Philippines, Alipay in China and PayPal, Venmo and Square in the U.S.; which now offer shadow banking services like deposits, remittances, payments and loans to small clients. These alternative banking platforms are a growing threat to traditional financial institutions. The question is whether these fintechs should be subject to the same capital, reserve and liquidity requirements and BSP supervision as banks. In China shadow banking has become a problem.

The Government is set to merge the Landbank and the DBP to strengthen the combined finances and save on fixed costs with LBP the surviving entity. Yet the same Government is about to carve out over 50% of their capital or P75 billion to finance the Maharlika Fund. What the Government giveth it takes away. The merger will also muddle the mission of these two institutions – the LBP was originally mandated to support agriculture, the DBP industrialization. Legislators may want to review the merger in terms of its confusing mission, the consequent layoffs and the quality of their respective management. I recall a time when the LBP was said to have one of the worst management and balance sheets and was kept afloat largely by Government deposits. Is this a case of shoring up the LBP? We do not know but legislators may want to inquire.

The Philippine banking system is safe but this does not mean it is doing its job where most needed i.e. to intermediate monies fairly across economic sectors and classes. Like airlines serving mercenary routes, the banks should give back to the community.

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