How to buy a bank with £1

OF SUBSTANCE AND SPIRIT

*(Part 1)

* These are interesting times. The Philippine Senate is about to discuss the final version of the Maharlika Investment Fund (MIF). This bill went through several public hearings and three meetings of the technical working group. Lest we forget, the proposal is to earmark funds from government financial institutions (GFIs) such as Land Bank and DBP, dividends from the BSP and government-owned-and-controlled corporations (GOCCs) to the Maharlika fund. We can only see big trouble for the economy and the financial system. Since funds from these public institutions are mandated to support the investment fund rather than the budget, the national government (NG) will have to find other sources, but there are none. Congress will never realign the budget to reduce the allocations for health, education, infrastructure and other social services. Or the extra fat in the budget. They are all virtually written in stone. The only way to fund the bigger budget deficit is for the National Treasury to borrow more through higher issuance of government debt here and abroad. While wealth tax could be a good source of additional funding, or collection of some tax liabilities, this is a difficult proposition. Imposing higher taxes may not be the best alternative, but it is the only alternative. Or NG can do both: borrow more and tax more. It’s the NG that takes the hit. Congress in effect directs GFIs how to use the money of the general public and the government itself. Let us not forget that the NG and local governments deposit tax and non-tax revenues, and transact business with GFIs. GFIs’ investments in MIF are deductible from their regulatory capital. For this reason, GFIs could be constrained from lending to key areas of the economy and investing in other infrastructure and social development projects. This limits GFIs’ portfolio diversification to spread the risks. Moreover, the proposal for the BSP to extend prudential and regulatory relief to participating GFIs has inherent moral hazard risks because their overall risk profile could be underestimated. What is at stake here is the safety and soundness of our banks. Any sign of trouble, or red flag, is enough for the depositing public to be nervous and potentially cause bank runs and contagion to other banks. Interesting times indeed because big bank closures were recently reported in the US. What is striking here is that the banks involved, presumably anchored on their press releases, all point their fingers to the US Fed for their enormous escalation of policy rates to bring down inflation. Some described the banks as having been “Powelled,” obviously alluding to the US Fed Chairman. While the circumstances square off with the challenge of high cost of money, it is also fair to say that the banks were not exactly in perfect shape. Silicon Valley Bank (SVB), the 16th largest bank in the US, was padlocked and taken over by the federal insurance authorities because of heavy withdrawals by several big venture capital funds. Yes, liquidity was being tightened by the US Fed and SVB could not therefore meet the withdrawals unless they sold their shares low and absorbed a heavy toll on their finances. SVB’s fixed income investment came under water because of high interest rates. The problem with this bank is its extensive exposure to tech startups and venture capital. This type of borrowers is cash-intensive and therefore vulnerable in this high-interest rate environment. It is easy to blame the central bank and the high interest rate regime for this fiasco. But this is wrong. The US Fed is correct in implementing a tight monetary policy to defeat a stubbornly high inflation in the US. Once this is done, the collateral harm that includes the dampening of domestic demand, credit crunch and perhaps economic slowdown could be tackled. But not doing it now could lead to more disastrous results. This was the same fear of many who resisted the tight monetary policy of the BSP but they were proven wrong when, despite the huge increases in the BSP policy rates in 2022, the Philippine economy ended the year with great resiliency by growing at 7.6 percent. It cannot be argued that the tight BSP monetary policy was helpless in the face of supply-driven inflation because without it, inflation expectations could have been many times higher. In the case of SVB, it was a case of bad management. With deposits of around $175 billion, depositors’ withdrawal of some $42 billion or a quarter is just too much. Most of the deposits are short-term, the product of many initial public offerings of SVB’s tech clients in the recent past. But there was only very small portion that went into lending because the US is suffering from a debt-averse market. SVB management therefore opted to go big into higher-yielding long-term government bonds and 10-year mortgage-backed securities (MBS). This search for yield was SVB’s downfall. It was a duration mismatch, borrowing short through deposits and lending long through government bonds and MBS. As for the impact of higher Fed rates, Andy Kessler of Wall Street Journal wrote, “everyone, except SVB management it seems, knew interest rates were heading up.” But SVB kept business as usual without, it seems, any risk management system in place. Kessler wrote that SVB was without a chief risk officer for all of eight months. As a result, billions in public deposits were held hostage. The second bank is New York’s Signature Bank, the third largest failure in US banking history. Even with $110.36 billion in assets and $88.59 billion in deposits at the end of last year, Reuters reported that this big bank was shocked by its own investors who were unnerved by the rapid decline — within 48 hours — of the heavy withdrawals in SVB. What happened to the rest of the US banks is an excellent illustration of what contagion is all about. Immediately after SVB collapsed, US banks sustained a decline of about $100 billion in their market value. The third bank is Silvergate Capital with assets aggregating $100 billion. Serving mostly crypto clients, Silvergate also experienced heavy outflows of deposits. Accepting deposits of crypto assets since 2018, it collapsed after the downfall of FTX, the futures exchange that used to operate a cryptocurrency exchange and crypto hedge fund. The bank was forced to sell investment securities at a big loss to service their depositors and comply with the strict regulatory regime. There could be more banks at risk of bank runs with reported uninsured deposits of as much as $1 trillion. These are cautionary tales not only to Philippine banks but also to the authorities including Congress that is so sanguine to tap funds from the GFIs and the monetary authorities themselves to support one singular Maharlika fund. These are indeed interesting times. *(HSBC subsequently bought SVB’s banking subsidiary in UK for £1)* *(Next week: How to avoid selling banks at £1)*