In another brilliant article, Matt Levine gives us fine examples of borrowing short to lend long, explaining beautifully why many banks don’t like mark-to-market accounting, dissecting why the Fed is Lender of Last Resort and the only two options presented to save $SIVB to it, and a bit more about the Fed’s reaction.
Also a percolating cup of the $SBNY news straight from Matt’s Microwave vision. The irony here is that one of the author’s of the Dodd-Frank Act which tightened up banking rules - Barney Frank - is an actual board member of this newly insolvent bank. Oh. the irony. Anyway, Matt explains they were very much like Slivergate ($SI) as 90% of their deposits were large and unsecured, and there were loads of crypto clearing and deposits.
Matt also answers a reader’s question about the BFTP, and Matt did the legwork to answer his questions, and it is very informative about how this works.
Lastly, Matt looks closer at two “stablecoins.”
The way a bank works is that it borrows short to lend long. Simplistically, a bank might get its money from demand deposits, checking and savings accounts that customers can withdraw at any time. And the bank might pay, say, 0% interest on those deposits. And then it invests the money in some longer-term assets, loans and bonds that don’t get paid back for years, and that pay, say, 2% interest. The bank earns 2% on its money, pays 0% to depositors for the money, and keeps the spread, the net interest margin, which is 2% in this example.
Sometimes interest rates go up or down, though. Simplistically, short-term interest rates in the US are set by the Federal Reserve, which will raise interest rates to cool the economy if inflation is too high.
This is a risk for a bank’s borrow-short-to-lend-long business model. If the Fed suddenly raises short-term interest rates to, say, 3%, then you have to start paying 3% on your deposits. Meanwhile long-term interest rates have probably also gone up to, say, 5%, but you are still earning the old 2% on your loans and bonds, because they are long-term loans that don’t get paid back for years. Your net interest margin is now negative 1%: You pay 3% on deposits and earn only 2% on loans and bonds.
This is an obvious problem and much of the business of banking is about managing it. Here are some simple things that you can do:
More at the following link: