Financial services: bank runs stoke accounting debate

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How much is a bond worth? In 2023, investors learned that it depended on what you intended to do with it. 

Think, for instance, of the US regional banking crisis that kicked off with the collapse of Silicon Valley Bank. The lender had put depositor money into a large portfolio of US treasury bonds whose value fell as interest rates rose.

The bank had classified the bonds as “held to maturity” (HTM), which meant that it only needed to record unrealised losses in a footnote. It was not forced to raise capital against them. But when wealthy tech customers withdrew their deposits in droves, HTM turned into “flog as fast as you can”. Losses leapt from footnote to capital.

The debacle sparked a debate about whether the distinction between HTM and “available for sale” (AFS) securities made any sense at all. Clearly, intent changes with circumstances. On top of that, HTM gives institutions the chance to flatter their accounts. The Wall Street Journal reported earlier this year that, in 2022, six financial institutions moved half a trillion dollars from AFS to HTM.

This, investors should note, is a bigger problem in the US where banks have bigger holdings of debt securities. In April, the IMF said that fully accounting for unrealised HTM losses would have a “modest” impact on regulatory ratios of the median bank in Europe, Japan, and emerging markets.

Why not, some mused, force banks to mark everything to market and be done with it? 

Seductive as it sounds, this may not be the best solution. Banks are in the business of maturity “transformation”. If the value of their long-duration assets swung wildly, their alternatives would be to raise a lot more capital or lend at shorter durations. 

HTM makes sense as long as it is sensibly applied to small enough portfolios of securities, which have a small enough chance of needing to be sold. Regulators have now woken up to this. They should resist the temptation to forget the lesson as rates begin to fall. 

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