Is the SBV collapse a precursor to a financial crisis?

Last week’s difficulties for SVB Financial Group in the US can be added to other pockets of tension.

Investors’ fret that the sharp increases in policy rates and bond yields seen over the past year or more will eventually lead to significant financial dislocation. Last week’s difficulties for SVB Financial Group in the US can be added to other pockets of tension, such as difficulty in the crypto sector or the UK’s Liability Driven Investment (LDI) problems of last September/October. Could these relatively minor events be a precursor to a deeper financial crisis? Mr. Steve Barrow, Head of Standard Bank G10 Strategy, doesn’t think so, although he dares say that more such minor episodes seem likely.

The nub of the problem for both SVB Financial and LDI in the UK was that higher rates had eroded the value of assets. When SVB took a loss on its bond holdings, the hit forced it into a capital-raising exercise that was not accepted by the market.

In the UK, LDI providers were caught out by rising yields and the consequent need to fulfill margin requirements. Of course, many might argue that questionable practices contributed as well, but there seems little doubt that rising rates caused most of the problems, and that’s why the broader financial market recoiled.

Given that rates have already risen a long way, at least at the front end of the curve, and given that there’s more to go, it might seem reasonable to believe that a much bigger financial explosion is just around the corner. In particular, investors will be on the lookout for companies that are forced to sell loss-making assets. Undoubtedly, many do hold loss-making assets. But if we look at banks, for instance, the losses on asset holdings need to be set against the improvements in interest earnings as rates rise.

For governments, there’s some focus at the moment on the hit they are taking as central banks experience losses on their bond portfolios and pay much higher interest payments on reserves to commercial banks. But here the losses are just the mirror image of the gains made previously as policy rates were very low and bond yields fell during the quantitative easing process.

In short, Mr. Steve Barrow finds it hard to believe that the really big players in financial markets, such as governments, central banks, and systemically important banks, are in a position where some sort of implosion could happen at any stage.

But clearly, this does not rule out the possibility—or even the probability—that bad things will happen. The question is whether sufficient financial instability can result from events such as the SVB Finance collapse, crypto firm tensions, and LDI strains to create broader stress that materially impacts things like funding markets. If this were to happen, we’d see financial stress cascade through the system, potentially creating a need for policymakers to reverse course, at least temporarily, just as the BoE had to do last year by purchasing gilts.

"We see it as unlikely that there will be this degree of financial stress, although we don’t doubt that pockets of stress will reveal themselves and temporarily challenge the orthodoxy that central banks can continue to hike rates with impunity. We do not expect central banks to be knocked out of their stride by any such bouts of strain. Hence, at this early stage, we are not going to say that the Fed will pause its rate hikes given the SVB collapse. By the same token, we do not expect Treasury yields to come crashing down or the dollar to surge dramatically on some sort of safe-asset splurge by investors. We do see lower yields over time, but that’s because of falling inflation and a likely recession. And, as for the dollar, we have been and continue to expect near-term strength, but we’ve been clear that we see this as being modest, at no more than parity for euro/dollar, for instance. Quite clearly, these sorts of forecasts could prove incorrect if things like the SVB Finance collapse and the LDI fiasco in the UK are precursors to a broader financial crisis. But we don’t think that this will be the case", said Mr. Steve Barrow.