The banking and financial world is getting chaotic by the day! The collapse of three US banks: SVB, Silvergate, and Signature last week has opened a can of worms. The bank failures have triggered a global concern as this could just be the tip of the iceberg.
The unwinding of Mr Bernanke’s zero interest rate policy is causing unprecedented upheaval as the rapid-fire interest rate hikes in 2022 resulted in the worst losses in the US bond markets in the last five decades.
The American banks were, however, sitting pretty on the MTM (Mark to Market) losses which have now swelled up to a staggering USD 620 billion figure. Thanks to the ingenuity of the US bankers, legal luminaries, and politicians, the banks are not required to reflect the impairment in the bond valuations in their balance sheets cause the FED repealed Rule No 137 during the 2008 financial crisis.
US Banking Crisis’ Global Implications
The FED has yet to come out with its new tool of BTFP: Bank Term Funding Program to help the banks avoid booking losses on their bond portfolios in case they have a liquidity crisis.
The window offers a loan against US treasury securities at Par value regardless of the diminution in the market value. Is it the start of another Quantitative Easing (QE)?
The world is nervous now about the health of US banks. The health of the economy was already a subject of debate and now things are getting messier. In the last three days, global banking and equities in general have seen a massive capitulation in valuations. The loss is upwards of USD 450billion.
Bank’s Local Start-Up Push Faces a Blow
SVB bank may be a relatively unknown bank in India, but it was the 16th largest bank in the USA with banking assets of about USD 212bn. As big as some of the top private banks in India! SVB was primarily funding the start-up community.
Many of the Venture Capitalists(VCs) endorsed the SVP bank to Start-Ups for their banking facilities. As a result, the bank saw huge deposit growth in the last three years as the VC funding was at its peak. Most of these deposits were accepted at near-zero interest rates in consideration of the borrowing limits! Till the time VCs were funding, the starts-ups deposits kept on increasing, SVP parked their surplus deposits in long-dated low-yielding bonds about USD 54bn!
Mistake number one, they were long-dated bonds! Mistake number two, the bank presumed the interest rates will remain low! So they never hedged their interest rate risks even when the FED made it clear that it will raise interest rates till they achieve a 2% inflation rate. Risk management was clearly a low priority for the bank.
The average yield on the bonds was 1.57% with a maturity of 10 years! As the yields on 10-year paper moved to more than 3.8%, the bond valuations dropped significantly.
The treasury and risk management teams at the start-ups look to be equally incompetent, placing all eggs in one basket. 89% of the bank deposits were uninsured! Another gaffe by the depositors!
As the bank was under stress to raise Capital because of increasing Deposits it announced its intention to raise Capital while simultaneously booking a loss of USD 1.7bn on the sale of its bond portfolio.
On Friday, the murmurs of bank losses started doing the rounds in the VC circles and the Depositors placed a request to withdraw USD 42 bn so by the end of the day, the bank was belly up! So more than the FED the bank itself is to be blamed for its collapse. A lot of Indian start-ups are exposed to SVP. The inability to access the deposits and credit lines would have serious repercussions on the sustenance & viability of the start-ups.
As a fallout of this, the start-up community will take a big hit not only in the US but across the globe as there will be a reassessment of credit funding risks to the Start-ups.
A Flailing Tech Industry: More Layoffs Expected!
The tech start-up eco system looks quite vulnerable, India included. While the valuations and the fresh fund raises already took a hit in the Tech meltdown last year, the drying up of credit funding will halt the cash burn!
There is a growing risk of widespread layoffs. In an adverse eventuality, in the short run, the broader Indian IT industry is also likely to take a hit on earnings as order flow could slowdown.
FED has been rightly concerned about achieving Price stability since the runaway inflation hit a 40-year high last year. After having failed to see Inflation as anything more than “Transitory”, in a short span of time, it increased the Repo rate to 4.75, to slow down the economy.
While CPI ( Consumer Price Index – Inflation) has come down to 6%, it is way above the Fed’s target rate of 2%. The Buoyant February Payroll data reignited the debate about larger interest rate hikes going forward. Interest rate hikes will further increase the MTM losses on the bond portfolio held by the US banks.
Besides the MTM losses, the banking industry is getting the jitters as the Housing Mortgage rates have shot up in a very short term without a corresponding adjustment in incomes. With the slowing down of the economy, banking NPAs are likely to multiply manifold and the collateral values are likely to diminish.
Personal credit card outstandings have crossed USD 1tn and together with the corporate borrowings, the total US debt now stands at the north of USD 61tn. With the rising cost of living, low saving rates, shrinking corporate earnings, valuation impairment of Tech companies, and drying up of funding to start-ups the banking sector looks under tremendous stress.
A little surprise Moody’s has downgraded its outlook on banking. Any banking contagion would affect all the banks globally and this is the last thing the Global economy needs as it already is heading towards a recession.
China, Japan, Europe, and the US are already seeing massive demand destruction underway. Together they account for more than 65% of the global GDP. Global trade is already at a low with the Baltic freight index hitting a level of 530, which was last seen in 1985 and briefly in 2016 and 2020. Rising interest rates in the US have a direct impact on global interest rates as it opens interest and currency arbitrage resulting in a flight of capital. The US dollar saw an unprecedented appreciation against the majority of global currencies last year on account of global capital inflows. Consequently, interest rates in India are also likely to rise in tandem.
Any liquidity stress in American banks will have a worldwide contagion. Emerging markets, India included will see a large-scale selling of FPI portfolios and capital outflows leading to larger fiscal deficits. Expect capitulation in Equities, hope it is not an encore of 1929.
But is the FED likely to increase the interest rates? The fund managers have been at loggerheads with the FED as they feel the central bank rate tightening will definitely break something – the economy, banks, monetary system housing, and mortgages!
After the SVB fiasco, the global bond markets have all rallied to a flight to safety, once again signalling a hope that the FED and other central banks will be forced to pivot.
Fund managers have taken positions in long-dated securities in the last three days as to them, the curve inversion was already suggesting that the market expectations of the dis-inflationary trend are setting in soon. Slowing retail sales and inventory build-up in the US and Europe are also indicating that the disinflationary process may have started. The fund managers are of the opinion that the FED would soon have to do a 180-degree U-turn.
Personally, I doubt if the FED is in any mind to listen to the bond markets. The FED has the mandate to bring in price stability, regardless of the volatility and instability playing out in the financial markets. Inflation is fast becoming a structural problem with the ongoing war and supply-side disruptions.
Frosty relations with China aren’t helping either. With inflation still above 6 percent, the Fed has realised it has a long road ahead with the sticky inflation. Any resumption of QE will send the country into hyperinflation. The 40-year relentless currency printing and the consequent asset price inflation have to end now even at the cost of breaking the economy and the financial markets.
Moreover, QE measures will result in a run on the US dollar, especially as now Russia, China, and a host of other countries are accelerating the De dollarization process. For once, the FED is at crossroads of whether to fix the real economy or to accommodate the financial markets.
The Indian economy is not totally insulated from the adversities in the global developments. Last quarter, India grew at 4.4 percent with exports slowing down considerably. The corporate earnings will deteriorate further on account of a slowdown in demand, increasing interest rates, and falling margins. Exports are already slowing down. The tech and startup ecosystem looks quite vulnerable with the paucity of global funding becoming a reality. FPI selling and capital outflow may increase the Fiscal deficit for the current year.
Most of the indicators are pointing towards a Global Equity meltdown, which may have already started. Expect Dow, Dax FTSE to hit new lows. With rising interest rates funds will start flowing to debt instead of equities.
As such, Indian equity markets remain one of the most expensive markets, The price-earnings ratios should move to more reasonable levels. As the corporate earnings are expected to fall, the equities are likely to see a sharp correction.
Indian equity markets are likely to hit a new low. Nifty IT index is looking weak, there could be a 15 to 20 percent correction in IT stocks in 2023. We could see levels of 14500 on Nifty this year. The US dollar will sooner than later start depreciating against the Rupee. Gold and silver look to be safe investments in this chaotic scenario. On a relative basis, India still remains a bright spot. Expect a global reset in 2023!
(The author is Managing Partner at Alquimie Advisors. This is an opinion article and the views expressed are the author's own. The Quint neither endorses nor is responsible for them.)