Yield curve armageddon for banks? We know a lot about banks as Metro Pulse is designed and continues to be tweaked as a community conduit for banks to interact with their hyperlocal markets via their physical branch networks when we finally find a suitable partner. When Trump took office he was wise to unlock the restrictions imposed by legislation spawned by 2008 crash. These relaxed restrictions included the release of massive amounts of reserve capital held by the US banking subsidaries of foreign banks as well as US owned ones. These foreign owned banking entities were required to hold 3 times the reserves against “bad paper” because of perceived global contagion in banking after the crash due to the interconnectivity of the global financial system. At the same time, the Federal Reserve blindsided the industry by rescinding the traditional “yield curve” mentality which was how banks projected future earnings thru regulated allocations of capital over a period of time. This was a key move because the amount of money any bank can borrow from the Fed at the predescribed low interest rate to make money on is at stake determined by these projections coupled with the yearly stress test required to assess the fiscal health of any given institution in the Fed purview.Known as the supplemental leverage ratio it defines the dollar amount a bank holds free and clear after all potential liabilities that is the benchmark that defines borrowing limits in fresh capital any given bank has in borrowing from the FED.It is this reallocation of excess capital from the US foreign bank subsidiary reserves and US ones to bonds in long term allocations that has the market freaked out. As shown with California based Silver Lake in particular, in the case of a “bank run” when a bank is forced to liquidate to cover deposits because of exposures in overly risky crypto positions that crashed, the value of the bonds they are holding because of fluctuating interest rates was worth less than what they paid for them creating massive losses in mandated liquidation. The fear of other banks holding the same paper in reserve and potential losses in “the spread” is what sparked the valuation adjustments we are seeing in this post.You will note the big banks are positioned to be somewhat immune to this as their positions more insulated by other profit centers but the US and foreign owned smaller midsize and jumbo midsize banks who may very well have parked their excess capital in bonds as a hedge during the pandemic are sitting ducks, just like 2008 with the mortgage backed securities that crashed for no direct fault of their own. Pop quiz later 🙂

Written by Michael E Dehn

Founder and CEO of Metro Pulse a continually running enterprise since May 1980.

March 10, 2023

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