An Update on the Banking System
Due to the recent closures of Silicon Valley Bank and Signature Bank, financial companies across the globe have come under intense scrutiny. While we can never be 100% certain that all issues are behind us, we do feel the banking sector is safe, depositors’ money is not at risk, and the probability of systemic failure remains very low.
The failure of Silicon Valley and Signature were heavily influenced by their depositor base and a lack of internal risk management controls2:
- Silicon Valley and Signature had significant deposits, including substantial amounts of uninsured deposits, from the technology and cryptocurrency industries respectively
- The outflow of cash from these industries combined with deposit reductions from customers looking for higher yield created a need for cash.
- No bank holds all of their deposits in cash – customer deposits are used to make loans as well as buy securities such as US treasuries
- Many of the assets held by Silicon Valley and Signature were longer maturity treasuries, mortgages, and agency debt – assets that were negatively affected by the significant rise in interest rates
- The sales of these assets to meet depositor demands created considerable losses and caused the need for Silicon Valley and Signature to access capital
- In attempting to secure greater capital, Silicon Valley looked to raise money through equity issuance, but the lack of trust and speed of depositor outflows made this unacceptable to investors
- As a result, both banks failed
As a result of the bank failures, the Federal Government took steps to ensure the safety of depositors for these institutions1. Second, they provided initiatives to provide liquidity to banks to avoid forced asset sales.
- Depositors, even those above the FDIC insured limit of $250,000, were protected and would have access to all cash previously held at these banks
- The Federal Reserve and US Treasury established the Bank Term Funding Program, which allows for one year loans to banks to use treasuries, agency debt, and US mortgage backed securities as collateral and valued at par. This action allows banks to access cash to meet depositor demand without the need for a fire sale of assets.
As we move forward, it is our opinion that the banking system will remain safe, but will almost certainly face future regulatory constraints to address the issues that caused the collapse of Silicon Valley and Signature. However, the reasons we don’t believe these issues are systemic include:
- Financial institutions outside of Silicon Valley and Signature have less concentrated exposure to specific industries and are much more broadly diversified
- Most financial institutions have risk management controls on the short versus long term maturity assets held to meet depositor demand
- Through the Bank Term Funding Program, banks are now able to access cash from the Fed to provide liquidity to depositors without the need to sell assets at significant discounts
Based on our opinion that these issues are not systemic, Gradient Investments purchased two financial institutions that we believe have been overly punished from the recent decline in financial sector stocks. In the Contrarian Choice portfolio, we purchased Charles Schwab (SCHW) and in our G50 portfolio, we purchased Goldman Sachs (GS).
In the short term, Gradient Investments expects continued market volatility as stress in the financial sector combines with continued concerns regarding inflation and the potential for a recession. We will continue to monitor actions happening in the financial sector and communicate any changes to our overall outlook.