The People’s Bank of China – being the Chinese central bank – has outlined lessons to be drawn from the recent collapse of Silicon Valley Bank (SVB) in its First Quarter Monetary Policy Execution Report (2023年第一季度中国货币政策执行报告) released on 15 May.
Chief amongst these lessons include the need to step up monitoring of smaller financial institutions that still have the potential to pose systemic risk, as well as avoid outsize moves when it comes to the implementation of monetary policy.
PBOC pins SVB collapse on interest rate hikes
The Report dedicates an entire column to the recent collapse of US regional lender SVB, amidst unrelenting hawkish monetary policy from the Fed.
In PBOC’s analysis, SVB collapsed as a result of interest rate hikes that hit the cash flow of tech companies, leading to deposit outflows that eventuated in bank runs.
“Against the backdrop of the Fed’s steep interest rate hikes, the cash flow of start-up companies tightened, and Silicon Valley Bank’s deposits continued to decline,” the Report said.
“It was necessary to sell securities assets to replenish liquidity, causing its securities assets to transform from floating losses to real losses. Huge losses triggered a massive run, with Silicon Valley Bank seeing withdrawals of as much as $42 billion on March 8 alone.”
The Report further points out that the SVB collapse was not an isolated incident resulting from poor risk management, but part of broader problems in the US banking sector triggered by interest rate hikes.
“After the Silicon Valley Bank incident, some small and medium-sized banks in the United States were greatly affected by spillover impacts due to unstable deposit sources, large securities book losses, and poor profitability,” the Report said.
The PBOC report points in particular to Signature Bank – which endured a bank run and was taken over by the Federal Deposit Insurance Corporation (FDIC) on 12 March, and First Republic Bank, which lost more than $100 billion in deposits in the first quarter. First Republic was taken into receivership by FDIC on 1 May, with JPMorgan Chase since buying most of its assets and liabilities.
SVB collapse a wake-up call for PBOC
The PBOC report took pains to emphasise the stability of the Chinese banking system and its lack of exposure to the SVB collapse. It nonetheless pointed out that the recent problems afflicting the US banking sector provided piquant lessons for China.
“The risk exposure of China’s financial institutions to Silicon Valley Bank is small, and the impact of Silicon Valley Bank’s bankruptcy on China’s financial markets is controllable,” the Report stated.
“At present, China’s financial system is operating steadily. The banking industry, which accounts for more than 90% of the total assets of the financial industry, is stable overall. The vast majority of banking financial institutions are within the safety zone. The 24 large -scale banks account for about 70% of the total assets of the banking secto have continually maintained excellent valuations.
“It is also necessary, however, to summarize and reflect upon the lessons learned from the Silicon Valley Bank incident.”
PBOC summarised the lessons for China from the SVB collapse in four points:
- Monetary policy should avoid large-scale expansion and contraction. “During the pandemic, developed economies implemented quantitative easing policies, rapidly implemented zero interest rates, and then quickly raised interest rates due to high inflation, shrinking their balance sheets. This prompted commercial banks to make allocations to low-yield assets during the easing phase, before needing to balance them with high-interest-rate liabilities during the tightening phase. inducing large losses. By comparison, China adheres to a stable and normal monetary policy, taking into account short-term and long-term economic growth and price stability and internal balances and external balances. This stabilizes sustainable support for the real economy, effectively maintains price stability, and promotes the smooth operation of the national economy, laying a solid foundation for financial stability.”
- Attention must be given to the regulation of small and medium-sized financial institutions. “After the 2008 financial crisis, countries have in general strengthened the assessment and supervision of systemically important financial institutions, while paying relatively limited attention to small and medium-sized financial institutions. In 2018, the United States decided to implement classification-before supervision of financial institutions. Prior to its bankruptcy, Silicon Valley Bank belonged to the ‘fourth category’ of institutions, and applied relatively loose prudential regulatory standards. No stress tests had been conducted before. In fact, small and medium-sized financial institutions have weaker pressure-tolerance and more manifest vulnerabilities, and may also cause systemic risks amid risk accumulation and market panic.”
- Financial risks must be dealt with quickly and forcefully. “Risk disposal for Silicon Valley Bank was fairly swift. The FDIC took over Silicon Valley Bank in accordance with the ‘May 1st Mechanism,’ that is, it announced the takeover and establishment of a bridging bank on Friday, and reopened on Monday. The U.S. Department of the Treasury, the Federal Reserve, and the FDIC also quickly performed legal procedures and promptly announced full guarantees for all depositors of Silicon Valley Bank, which stabilized market confidence. This shows that rapid and strong response measures are crucial to stabilizing market confidence and dealing with financial risks, and also reflects the importance of sufficient legal authorization, abundant policy tools, and sufficient risk management resources, all of which is worth heeding.”
- Attention should be paid to the stability of the bank’s asset-liability structure. “From the perspective of liabilities, most of Silicon Valley Bank’s deposits came from start-up companies, with high customer homogeneity and a low proportion of savings deposits. More than 90% of deposits were uninsured deposits and the liability structure was not stable. From the perspective of assets, Silicon Valley Bank’s loans accounted for only 35% of its total assets, 57% of its assets were invested in U.S. Treasury bonds and mortgage-backed securities, and it lacked effective hedging arrangements to deal with interest rate risks. The instability of this asset-liability structure eventually led to liquidity risk. In light of this, banks should make effective use of risk management tools such as stress testing, fully consider various risk scenarios, and prepare response plans for extreme contingencies, so as to match their own risk management capabilities with their asset-liability structures.”
PBOC said that in future, China’s financial authorities “will continue to strengthen the development of the financial stability guarantee system, and firmly hold the bottom line against the onset of systemic financial risks.”
Key measures will include:
- Accelerating the development of the financial stability legal system, promoting the introduction of the “Financial Stability Law”, and strengthening market-based and law-based financial risk disposal mechanisms.
- Strengthening financial risk monitoring and early warnings, and giving full play to the role of the deposit insurance system as a platform for early correction and market-based risk disposal.
- Continuously diversifying sources for financial risk management, improving the management mechanism for financial stability protection funds, and cooperating with deposit insurance funds and related industry protection funds to jointly maintain financial stability and security.
Focal points for the Chinese central bank ahead
The Q1 Monetary Policy Execution Report outlined key focal points for PBOC in the near-future, including:
- Maintaining an appropriate and stable pace of monetary and credit aggregates. “A variety of monetary policy tools will be used comprehensively to maintain reasonable and sufficient liquidity, and to keep the growth rate of money supply and social financing basically in line with the nominal economic growth rate.”
- Structural monetary policy will focus on key points, remain rational and moderate, both advancing and retreating. PBOC said it would “maintain the stability of re-loan and re-discount policies, and continue to provide inclusive and continuous financial support to agriculture-related, small and micro enterprises, and private enterprises.”
- Build a financial system to effectively support the real economy. “Continuously carry out the assessment of the effectiveness of credit policy guidance for small and micro enterprises, supervise and guide financial institutions to accelerate the establishment of a long-term financial service mechanism for small and micro enterprises to dare to lend, be willing to lend and be capable of to lending, and improve the availability and convenience of financing for small and micro enterprises.”
- Deepening the market-oriented reform of interest rates and exchange rates, prioritising China and taking into account internal and external balances. PBOC said it would “continue to advance market-based reform of interest rates, improve the central bank’s policy interest rate system, improve the formation and transmission mechanism of market-oriented interest rates, and guide market interest rates to fluctuate around policy interest rates.”
- Continue to deepen financial reform and accelerate the development of a financial market system. PBOC will “continue to promote the reform of development-oriented and policy-oriented financial institutions, achieve business classification management and separate accounting, strengthen capital constraints, strengthen risk management, improve incentive mechanisms, consolidate the main responsibility of institutions, in order to better utilise them in the key roles of serving the real economy and serving national strategies.
- Persevere in preventing and defusing risks. PBOC will “further improve the macro-prudential policy framework, improve systemic risk monitoring, assessment and early warning capabilities; enrich the macro-prudential policy toolbox, and steadily expand the coverage of macro-prudential policies.”