All banks are local when they die

The Farrow group of building societies, the most notable being the ironically named Pyramid, collapsed in the early 90s after bank runs and a mass of bad loans.

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In many ways it was a textbook failure of a deposit taking and lending institution. The run, sparked by rumours the group was insolvent, was just one of many failings which included poor management, overpaying on deposits and bad credit decisions, notably in lending to property developers.

Less and more expensive liquidity becomes a third order impact as those business directly impacted start to shrink back, unemployment rises, consumer confidence declines and economies slow, even go backwards into recession.”

It is also a textbook example of the second and third order impacts of banking crises and the damage even smaller institutions can wreak when they fail. The Farrow Group was based in Geelong in regional Victoria and when it failed it sparked a regional recession, cost taxpayers nearly a billion dollars and destroyed hundreds of local businesses, driving unemployment rates in the affected regions well above state averages, for years.

This is what to expect with the latest banking crisis and collapses. Banks are fundamental to a healthy economy. They mediate between those who have excess funds and those looking to borrow to make investments. They facilitate payments.

Bendigo and Adelaide Bank is a positive example of how a regional bank in Australia has contributed to its region around Bendigo in Victoria performing better economically than similar regions.

Meanwhile the collapse of banks including Silicon Valley Bank (SVB) in the US will undoubtedly impact their communities. In SVB’s case this is the tech and startup community as well as, in a twist, the Californian wine industry.

That’s because, according to CB Insights, SVB was one of the most active players within the fintech landscape, with over 2,600 fintech clients.

“As a lender, banking partner, and payments technology provider, SVB had built deep connections with a vast number of startups across more than a dozen areas of fintech,” the research firm said. “In fact, it markets itself not as a bank, but as a financial technology partner. According to SVB, its clients account for 71 per cent of all fintech IPOs since 2020. It’s clearly plugged into the fintech ecosystem. The fallout from recent events may leave a hole in fintech that won’t easily be filled.”

Rather than let SVB fail completely, the US government and regulators decided to guarantee all deposits at the banks rather than the US$250,000 per account covered by deposit insurance. Given SVB clients, notably startup entrepreneurs, had habitually deposited the funds from equity raisings into SVB deposits, this decision sheltered billions of dollars.

As in previous crises, any action to protect stakeholders brings with it moral hazard – if you assume your deposit is guaranteed even if it exceeds formal limits you are less concerned with the risk of failure of failure of the deposit-taking institution.

Meanwhile, an institution which can assume an implicit bailout will take greater risks in the search for higher returns than one which operates under the sword of potential failure.

The US authorities reacted in the way they did because of the second order impacts. If those in that Silicon Valley startup economy lost their deposits, they would probably cease to be viable with devastating consequences for innovation in the region. That in turn would in all likelihood drive a severe recession in that part of California, at least.

SVB’s failure was not sudden and exemplifies another element of financial systems: the symbiotic relationships between the economy and its banks. Banks thrive when economies thrive and can then finance further growth in the economy.

However, the turn in the interest rate cycle, from more than a decade of near zero rates, had already started to pressure any business model which relied on ultra-cheap and easily accessible money. When rates are so low, investors are prepared to take more risk for relatively little extra return. But when official rates are higher, investors can afford to be a lot less risky.

As ANZ chief executive Shayne Elliott pointed out in a recent discussion with bluenotes, “when liquidity dries up, two things happen. It becomes more expensive for those who can get it and not everybody can get it, so it becomes rationed. So, in that event, the real question is who are those businesses, and households potentially, that really depended on that liquidity availability? Who are they? And who are the people who can't afford the higher cost?”

Less and more expensive liquidity becomes a third order impact as those business directly impacted start to shrink back, unemployment rises, consumer confidence declines and economies slow, even go backwards into recession.

Looking at the benchmark US Treasury note, rates really began to rise in mid 2020 but the kick started just over a year ago.

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The latest Reserve Bank of Australia bulletin published an analysis of the Australian situation in an article Developments in Banks’ Funding Costs and Lending Rates. As funding costs rise for banks they are passed on, tightening credit in the real economy.

“The effects of tighter monetary policy over 2022 have driven a substantial increase in banks’ funding costs,” the RBA said. “In turn, banks have started charging higher interest rates on loans to households and businesses over this period. As such, the cost of borrowing for many households and businesses has increased considerably for the first time in over a decade, leading to a significant tightening in financial conditions for these borrowers.”



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The vignerons of the Napa Valley were perhaps not the first sector you might think of to suffer collateral damage but banks and economies and so intertwined it is difficult to pinpoint exactly where pressure will build.

As a rule, riskier ventures – those with long return horizons or histories of volatility like commercial property – are often hit. Venture capital and private equity are both leveraged to the cost of funding and liquid markets. Often these firms look to raise debt in companies and restructure before selling into public markets at a profit.

Typically too there is a flight to “quality” – more secure investments. In banking that tends to mean large, conservative, highly capitalised and regulated institutions. For entrepreneurs, and especially in Silicon Valley, these are not usually the first port of call.

As Andrew Endicott, a founding partner of Gilgamesh, an early-stage venture fund investing in fintech, said in an interview with The Financial Revolutionist “we need banks of all sizes because a lot of the banks that are not in the top five play very important roles. They serve important roles for fintechs and startups like SVB did; they offer things like venture debt and special kinds of facilities and payments capabilities. It’s Important to have a lot of banks that serve local communities and small businesses.”

Right now, the global financial system appears to have stabilised after the regional bank failures in the US and the forced takeover of Credit Suisse by UBS in Switzerland.

But the era of near free money has ended. This is a seismic event. Looking at a post-SVB world in startups, Anand Sanwal, CB Insights founder, outlined the medium-term implications.

“And it is not pretty,” he said. “The implications include lower valuations, higher startup mortality, intensifying layoffs. There is lots of shocking data … around headcount at unicorns, tech IPOs, valuations, and more.”

For the moment that is a particular sector but the sustained environment of higher interest will play out right through the economy. And every bank is regional in some way.

Andrew Cornell is Managing Editor of bluenotes

The views and opinions expressed in this communication are those of the author and may not necessarily state or reflect those of ANZ.

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