US banking regulators on March 10 announced the closure of Silicon Valley Bank (SVB) and seized its assets to protect depositors’ money. The authorities shut down two more banks—Signature Bank and Silvergate Bank.
The US banking crisis is a classic example of asset-liability mismatch.
Let’s look at the SVB case closely.
Last week, depositors started pulling out their money and to meet that demand, the bank had to sell its investment in bonds whose value had declined due to rising interest rates.
SVB Bank had last week sold its $21-billion bond portfolio consisting of US Treasuries and mortgage-backed securities at a loss of $1.8 billion.
The bank had invested heavily in Mortgage-backed securities and US Treasuries last year through deposit money to earn higher returns. The bank had seen a huge influx of deposits but struggled to find enough credit demand to deploy that money at desired yields.
Over 95 percent of these mortgage-backed securities were over 10 years in duration, with a weighted average yield of 1.56 per cent.
As per reports, SVB had over $80 billion worth of investments in mortgage-backed securities.
Some of you may not have heard about Mortgage-backed securities. Here’s an explainer:
To start with, what are mortgage-backed securities?
A mortgage-backed security is an investment product that is backed by assets or a pool of mortgages.
The seller of this security usually aggregate the mortgages or a group of home loans and then sell it to individual investors or a group of investors.
The coupon payments on these securities are linked to payments made by mortgage borrowers.
How do mortgage-backed securities work?
To explain it in simple terms, the bank first provides a home loan to its customers and then sells that loan to investment banks to free up some capital for further lending.
The investment bank then pools or bundles up these mortgages and creates a mortgage-backed security, based on the credit quality, and sells it on to investors.
The holder of these securities gets income if the customers of that mortgage pool pay off their loans.
Also read: SVB resolution good for risk sentiment, not return of the Fed Put: Nomura
What are the types of mortgage-backed securities?
There are two basic types of mortgage-back securities which are pass-through Mortgage-backed securities and collateralised mortgage obligation.
In pass-through mortgage-backed securities, the issuers collect the monthly obligation from the pool of mortgages and then pass the share to the bond holders.
A collateralised mortgage obligation comprises multiple pools of mortgages, which are called tranches, and each tranche has a different maturity. The risker tranche in this offers higher returns.
As per official estimates, the market is very limited for collateralised mortgage obligation.
What is the size of the Mortgage-Backed Securities market in India?
According to the CareEdge Ratings analysts, in the current financial year, transactions of mortgage-backed securities worth Rs 39,800 crore have taken place, of which direct assignments were Rs 34,500 crore and pass-through certificates Rs 5,300 crore.
In FY22, transactions worth Rs 48,500 crore took place, of which direct assignment was Rs 41,200 crore and pass-through certificate Rs 7,300 crore.
Also read: HSBC acquires Silicon Valley Bank's UK unit for £1
Will Indian banks face any issues from such securities?
Experts said that the fallout of SVB Bank will have little to no impact on the Indian banking system as banks don’t have such exposure.
“Since this crisis has near zero impact on Indian banking, investors with a higher risk appetite can use the weakness in the market to buy high-quality bank stocks,” said VK Vijayakumar, chief investment strategist at Geojit Financial Services.
He added that a possible positive impact of the SVB crisis is that it may nudge the US Federal Reserve to adopt a less hawkish stance since the series of aggressive rate hikes by the Fed lies at the root of the SVB crisis.
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