SVB Financial Group, commonly known as Silicon Valley Bank (SVB), has faced declining deposits from its customers, many of whom are early-stage technology and life sciences companies. The bank has also lost $1.8 billion in the sale of U.S. treasuries and mortgage-backed securities due to rising interest rates.
This indicates the impact of interest rate risk, which was discussed in the FDIC Chairman’s speech as one of the uncertainties facing banks. The bank’s announcement of a $1.75 billion share sale to maintain its balance sheet has led to concerns among depositors about the safety of their funds. This highlights the importance of strong capital and liquidity positions, as emphasized in the FDIC Chairman’s speech, in mitigating risks facing the banking system. Later FDIC has announced closure of SVB Bank keeping in view depositors interest in mind.
Federal Deposit Insurance Corporation (FDIC) Speech.
Chairman Martin Gruenberg of the Federal Deposit Insurance Corporation (FDIC) recently spoke at the Institute of International Bankers, providing insight into the impact of the pandemic on the economy and the banking system over the past three years. Gruenberg noted the unprecedented nature of the recession caused by the pandemic, with the U.S. unemployment rate increasing from 4.4% to 14.7% in a single month, and GDP dropping 30% between the first and second quarters of 2020.
Despite the challenges presented by the pandemic, Gruenberg also highlighted the resilience of the banking industry during this period. He noted that while net income dropped by almost 37% in 2020 due to credit loss provisions, it has since recovered to record levels of $279 billion in 2021 as the economy improved and loan loss provisions decreased. Additionally, loan growth and favorable credit quality metrics, along with strong capital and liquidity positions, have supported the industry’s ability to absorb unexpected losses and meet credit needs during periods of adversity.
Overall, Gruenberg’s speech provides a valuable glimpse into the impact of the pandemic on the banking industry and highlights its remarkable resilience during this period of uncertainty.
Unrealized losses
The value of unrealized losses for a bank is the difference between the current market value of an asset and its book value, which is the value at which the asset is carried on the bank’s balance sheet. If the current market value of the asset is lower than its book value, then the bank incurs an unrealized loss. This loss is not realized until the asset is sold or written down on the balance sheet.
The value of the unrealized loss can be significant, especially if the bank holds a large amount of assets with market values that have declined below their book values. This can weaken the bank’s future ability to meet unexpected liquidity needs or to generate profits, as it may need to hold additional capital or liquid assets to offset the unrealized losses.
In his speech, FDIC Chairman Martin Gruenberg highlighted the impact of unrealized losses on the banking industry’s equity capital. Unrealized losses refer to the reduction in the market value of securities that the bank holds but has not sold. These losses are not reflected in the bank’s income statement but are recorded as a reduction in the bank’s equity capital.
According to Gruenberg, the total of these unrealized losses, including securities that are available for sale or held to maturity, was about $620 billion at yearend 2022. This means that the value of securities held by banks had decreased by $620 billion compared to their original purchase price.
These unrealized losses have a significant impact on the reported equity capital of the banking industry. Equity capital is an important measure of a bank’s financial health and represents the amount of capital that the bank’s owners have invested in the bank. It is also used to absorb any unexpected losses that the bank may incur.
When the value of securities held by banks decreases due to unrealized losses, the reported equity capital of the banking industry is reduced. This reduction in equity capital can affect the bank’s ability to absorb any unexpected losses that may arise in the future.
Therefore, the impact of unrealized losses on the banking industry’s equity capital is a cause for concern, and banks need to take steps to mitigate the risks associated with these losses.
Other Points in Speech
- The U.S. unemployment rate increased from 4.4% to 14.7% in a single month due to the pandemic.
- GDP dropped by 30% between the first and second quarters of 2020.
- Net income of the banking industry dropped by almost 37% in 2020 due to credit loss provisions.
- Net income of the banking industry recovered to record levels of $279 billion in 2021.
- As of yearend 2022, only 39 banks were on the FDIC’s problem bank list, and there were no bank failures.
- Some business lines, such as auto and credit card lending, may be sensitive to general price inflation, which could lead to increased repayment difficulties for cash-strapped consumers.
- Commercial real estate lending and construction and development lending grew in 2022.
- The structural changes in the economy associated with the increase in remote and hybrid work create additional uncertainty for banks.
- Higher interest rates have had a direct impact on banks’ income and expense.
- The office sector is presenting challenges due to the pandemic’s structural trends.
- Leveraged commercial and industrial loans are another credit category that could be affected by the higher interest rate environment or by a recession.
Conclusion
In conclusion, Chairman Martin Gruenberg’s recent speech at the Institute of International Bankers highlighted both the impact of the pandemic on the economy and banking system over the past three years, as well as the resilience of the banking industry during this period. The industry weathered the storm of the pandemic, with net income dropping by almost 37% in 2020 due to credit loss provisions, but recovering to record levels of $279 billion in 2021 as the economy improved and loan loss provisions decreased. This recovery was supported by loan growth, favorable credit quality metrics, strong capital and liquidity positions, and the ability to absorb unexpected losses and meet credit needs during periods of adversity.
However, the speech also emphasized the outstanding risks facing banks, including economic uncertainty, interest rate risk, and inflation. The recent inflation and interest rate increases have led to unrealized losses on securities, which have weakened the banking industry’s future ability to meet unexpected liquidity needs. Higher interest rates have also had a direct impact on banks’ income and expense, with banks needing to pay more interest to retain their deposits or accept some deposit outflows. The structural changes in the economy associated with the increase in remote and hybrid work create additional uncertainty for banks.
The speech concluded by emphasizing the importance of strong capital and liquidity positions in mitigating the risks facing the banking system. The downside risks are significant and will be a focus of supervisory attention by the FDIC. As of yearend 2022, only 39 banks were on the FDIC’s problem bank list, and there were no bank failures. Despite this, the FDIC remains focused on the challenges facing the banking industry and will continue to work to ensure the safety and soundness of the banking system.