Did You Know That You Are Like A Bank?
Much ink and bandwidth has been spent discussing the recent failures of Signature Bank and Silicon Valley Bank. We tend to think of banks as large and complex entities with lots of complicated financial engineering inside. And to some extent that is true. But the big picture is actually much simpler.
The two banks in question came to pass because they had what is known in the trade as a ‘duration mis-match.’ What the heck is that, you may ask? Banks take in deposits and pay you some (limited) sum of money in return. Maybe they charge you a little more if you would like to write checks against that account. At least they will require that you maintain a higher balance if you want some of those extra services to be available. Whatever the nature of the account, you, the depositor of the funds, can ask for you money back at a moment’s notice. Back in the old days you might have needed to travel to your local bank and speak to a person in a nice suit behind a large wooden desk, but you could walk out of the bank with a stack of bills or a cashier’s check. Today, all it takes is a couple of clicks on your computer or phone.
In the classic film “It’s A Wonderful Life” we were introduced to the concept of a “run on the bank.” Everybody in the town wanted their money back simultaneously. George Bailey, played by James Stewart, had lent out the money to others in the community and could not get the money back quickly enough. The loans were for homes, businesses, and other long term purposes. The depositors in the film understood and helped out. That doesn’t happen in modern finance.
Silicon Valley Bank (SVB) did all those things and also invested in some longer term bonds. They kept what they thought was sufficient cash around to return to depositors if they requested, but it wasn’t enough. Over 20% ($40mm of a total of $175mm) of all the Silicon Valley depositors asked for their funds in just two days!1 You see, SVB’s customer base were largely tech firms, venture capitalists, and they many of them talk to each other. One venture fund might own 20-40 smaller businesses each with accounts at SVB. It is logical that when the person who gave you the seed money to launch your business tells you that you should pull your deposits and find a new bank, it was a message many heeded. Word spread and a prominent person tweeted, and then it was over.2
Modern banks take in deposits, make some loans, and invest the rest in bonds of various maturities. So why didn’t SVB just sell the bonds and give depositors their money back? The longer the bond maturity the more sensitive it is to interest rates. Even a nominal amount of investment in longer term bonds was very quickly worth less after the FED raised rates aggressively. SVB had invested too much in bonds that were too far away from maturity.3 The bond investments had fallen in value such that the proceeds of any sale would not cover depositors’ demands, today.
The bonds in question are very likely to be paid in full, but today they were less valuable because interest rates rose. In fact, even US Treasury bonds, arguably the safest investment in the world, have fallen in value. Investors would receive 100% of the bond value when it matures, but not today.
Now think about your own asset allocation? If the value of your portfolio falls, are you holding a sufficient quantity of liquid assets to meet the short-term demands? Are you invested in too many volatile securities that may not provide the cash you need when you need it?
On the other hand, can you take advantage of this volatility in markets because you DON’T have cash needs in the near future? Could there be fantastic investing opportunities in the market driven by others who have not planned well? Undoubtedly the answer is YES!
Each investor will have different answers to this question but indeed, a duration mis-match at a bank is remarkably similar to the asset allocation questions you should be considering for yourself.
B. RIley Wealth Disclosure
Investing involves risk including loss of principal. Interest rate risk is the possibility that the value of an investment will decline as the result of an unexpected change in interest rates. The information provided is not directed to any category of investor and is provided solely as general investment education. None of the information should be regarded as a suggestion to engage in or refrain from any investment-related course of action as neither B. Riley Wealth Management, Inc. nor its affiliates are undertaking to provide you with investment advice or recommendations of any kind. The information herein has been obtained from sources believed to be reliable, but we do not guarantee its accuracy or completeness. The views and opinions expressed in this article are those of the author and do not necessarily reflect those of B. Riley Wealth Management, Inc. Opinions are subject to change with market conditions. Please consult your Investment Professional before making an investment decision. Securities and variable insurance products offered through B. Riley Wealth Management, Inc., member FINRA/SIPC. Fee-based advisory services offered through B. Riley Wealth Advisors, Inc., an SEC-registered investment adviser.
1 Washingtonexaminer.com, “SVB collapse: Here's everything you need to know”, March 13, 2023
2 Bloomberg.com, “Thiel’s Founders Fund Withdrew Millions From Silicon Valley Bank”, March 10, 2023
3 Morningstar.in, “What is an Asset-Liability Mismatch?”, March 12, 2023