Interest on loans should by increase a banks reserves every year barring massive defaults. The ROI for the actual reserves aren’t particularly relevant by comparison.
Similarly from a reserve standpoint they don’t need to worry about inflation as they need to pay back deposits in nominal terms not what the money is worth when withdrawn.
Higher interest rates decrease the value of long-duration bonds even in nominal terms. Think of it this way: because the interest rate on a bond is fixed at issue, and because newer bonds now have higher interest rates, your existing bonds have to be sold for less in order for someone to buy them over a newer higher-interest bond. This means that the banks' reserves have actually shrunk in value. This is made worse by the fact that the combination of low interest rates and requirements to choose safe investments means that the only way for banks to meet their cost of operations is by picking longer-duration bonds which have higher drops in value, and that they haven't been earning enough interest to really grow their reserves either.
That’s only relevant if you need to sell it or use mark to market accounting.
The US banking system has been given a great deal of regulatory leeway due to recent economic turbulence, including setting reserve requirements to 0%. So market value is only relevant if they need to sell before maturity.
Banks generally have liquid reserves to handle significant fluctuations in deposits. If that’s insufficient they have incoming cash flow and the option to borrow money to make up the difference rather than instantly selling assets.
Thus in practice extracting 5% over a week is fine but there’s a threshold that will kill any bank.
> Similarly from a reserve standpoint they don’t need to worry about inflation as they need to pay back deposits in nominal terms not what the money is worth when withdrawn.
The issue is that the sale value of their reserves has dropped below that nominal value. If you take in $1000 of deposits that you're paying 1% interest on and your reserve against that is a 10-year $1000 T-bill with a 2% coupon, you'd think you're fine, right? But if interest rates go up to 3%, you can't sell that T-bill for $1000 any more; if you can hold it to maturity you're fine, but if your customers start pulling their deposits you're in trouble.
Why would customers be pulling deposits unless you are offering lower than market interest rate? If T-bills are 3%, they can pay depositors 2% now and so whatever condition kept the customers there at -1% risk premium would still keep them there. No run on the bank. And given they are T-bills, duration is minimal, so $1000 might be worth $990 even before coupons. Whoop-de-doo!
There would only be a problem if the bank's credit deteriorated in its risky assets, enough to freak depositors out.
This is incorrect, as we learned from Silvergate. Customers pulled their deposits for reasons unrelated to the bank (in Silvergate’s case, the customers of the crypto exchanges wanted all their money back, so the crypto exchanges had to withdraw their deposits from Silvergate).
As Levine put it, it’s not an asset problem, it’s a liability problem.
It is not unrelated to the bank. They took concentrated callable funding that somehow was not matched to the liquidity of their assets. They took a risk.
This doesn't work either. Remember, the reason that the market value of the T-bills in their reserves has dropped is that the interest rate on them is lower than the current interest rate that people can get by buying them now, so the bank likely cannot afford to pay their customers a market interest rate of 1% below that. The only way for the hold-to-maturity value of their reserves to actually be realised is if customers don't withdraw their deposits and they don't have to substantially increase the interest rates they pay in order to achieve that - otherwise they're likely to run out of money, either quickly or slowly.
Right now there will be a lot of chatter if the root cause was industry concentration, mark to market, junior VCs scaring gulible founders, or as you pointed out: duration risk.
I think in five years the common narrative will be about duration risk.
To spell out what you hinted at: SVB will collapse at some point in the next few years. The only scenario they survive is if they survive this bank run, and then soonsih the fed lowers interest rates by a ton.
Otherwise even without this bank run SVB will still slowly be forced to sell off more and more HTM assets. Core reason being they cannot cashflow wise offer market rate interest on deposits. Clients _would_ move their money to better paying banks, not everyone but too many.
Thus this bank run only accelerates the inevitable. The interest broader note is how other bigger banks have or have not managed their exposure to duration. And special eyes towards the Japanese MegaBanks, double so if the bank of Japan does raise rates.
> Why would customers be pulling deposits unless you are offering lower than market interest rate?
Any number of reasons, particularly if all your customers are in the same industry. If you're "Silicon Valley Bank" and there's a downturn in Silicon Valley, well, here you are.
Yeah, this is how it's similar to silvergate. The main issue silvergate had was a lack of diversification of their liabilities, I.e. their depositors were all crypto. So when crypto hit a liquidity crises, it cascaded to silvergate. The same thing could theoretically happen to SVB, although that would look very bad on tech, since tech shouldn't really be an industry unto itself. Ideally, tech is just technology, and its application is across any industry.
The parent commenter is right, and the problem is the mark-to-market rule. This means that the value of the asset must be the current trading value, which goes down as the rates go up. The result is that bank reserves will go down substantially in nominal terms, sometimes faster than they can recoup the value of these investments.
That’s a regulatory rule which can be suspended not the underlying economic reality. “On April 9, 2009, FASB issued an official update to FAS 157[35] that eases the mark-to-market rules when the market is unsteady or inactive.” https://en.wikipedia.org/wiki/Mark-to-market_accounting
We’re currently in some interesting times: “As announced on March 15, 2020, the Board reduced reserve requirement ratios to zero percent effective March 26, 2020. This action eliminated reserve requirements for all depository institutions.“. https://www.federalreserve.gov/monetarypolicy/reservereq.htm
The key phrase here is "when the market is unsteady or inactive". Apparently this can be used to save banks, but not until there is trouble in the market.
Similarly from a reserve standpoint they don’t need to worry about inflation as they need to pay back deposits in nominal terms not what the money is worth when withdrawn.