Key takeaways:

• Australia banks are far less likely to encounter the sort of problems that SVB faced due to a diverse client base, deposits hedged to interest rate movements, and a strong regulatory framework  

With the collapse of Silicon Valley Bank (SVB) in the spotlight over recent days, and also sending reverberations around the world, a number of questions have emerged regarding the circumstances leading to the bank demise.

Locally, Australian investors have also turned their attention to the nation banks, wondering if similar circumstances might be plausible on home soil.

Although bank runs are always a risk for deposit-taking institutions across the world, the plausibility of such an incident remains exceptionally low for Australia banks on account of a number of important features and differences embedded in the local banking system.

Client Base

Over the span of its 40-year history, SVB established itself as a primary lender to the tech sector. During the boom years of the pandemic, this was a tailwind for the company as deposits swelled.

However, when the Federal Reserve began hiking interest rates in quick haste and the tech boom turned into a bust, the bank strength quickly turned into its biggest vulnerability.

Tech companies have felt the squeeze over the best part of the last 18 months as their cash flow has been strained. Furthermore, equity funding through capital markets has dried up as investors express concerns about the economic outlook.

With venture capitalists also concerned about the trajectory for interest rates as inflation remains stubbornly high, the bank concentrated client base provided little risk mitigation to SVB. In effect, being overly exposed to the tech sector meant that a large portion of the bank clients would all be facing the same industry-related concerns at the same time. 

Meanwhile, the deposit base across Australian banks spans a larger breadth of individuals and businesses from varying industries. There is less concentration risk, which means that retail deposits for the Big Four and co tend to be more sticky', whereas SVB deposit base was somewhat lumpy'.

Deposit Profiles 

One of the central reasons behind the collapse of Silicon Valley Bank was the profile of the deposits on its balance sheet. 

As SVB was unable to lend money out as fast as it attracted deposit inflows during the height of the pandemic, the bank invested a significant portion of its deposits into Treasury bonds and mortgage-backed securities in order to try to generate superior returns than available in money markets.

As Treasury yields soared in response to the Federal Reserve aggressive monetary tightening campaign, the value of the bonds and other securities held by SVB on its balance sheet took a large hit. In effect, these securities, alongside loans, accounted for a high portion of the bank deposits, and were highly susceptible to rising interest rates.

Fortunately, Australia banks have a different approach. Their principal investment activity sees them lend out depositors money to borrowers as means to generate earnings. What more, because Australian banks are mostly focused on mortgages, with the majority based on variable rates, the value of banks assets adjust with interest rates. 

Regulatory Framework

One of the peculiarities of the American banking system is that its banks may choose which body acts as its regulator. This includes the Federal Reserve Board, state-based regulators, or the Comptroller of the Currency. Regulations imposed by state-based authorities are less strict, which means smaller banks have been afforded more flexibility as far as capital requirements.

On the other hand, all Australian banks, no matter their size, are covered by the same regulatory regime. While regulations vary between regional and major lenders as far as mortgage risks, the same capital requirements apply across the board.

There is little doubt that the approach of Australia banking regulator, APRA, has resulted in stringent requirements. These measures ensure the financial system is underpinned by banks that have unquestionably strong capital benchmarks to protect depositors during periods of stress. Over the years, this even prompted banks to raise capital to bolster their balance sheets.

Furthermore, APRA introduced regulatory incentives that encourage lenders to balance their assets and liabilities. Unlike what we saw with SVB, and which ultimately led to its downfall, APRA proactively introduced a regulation that levies a charge against banks for interest rate risks tied to a difference in assets and liabilities. As such, Australia banks have set aside capital as rates lift.

Last but not least, one may make the argument that Australia (post-funded) deposit insurance scheme, facilitated by an industry levy, offers more scope to protect depositors. Some might argue that the pre-funded system in the US promotes fear during a bank run as depositors worry existing funds in the scheme may not be adequate to cover losses. As it turned out, only a fraction of SVB deposits were fully insured before the Federal Reserve ultimately stepped in to provide a guarantee.