Following the failure of Silicon Valley Bank (SVB) Financial Group, financial markets have been concerned about the strength of the US banking sector, and weary of the next bank(s) and financial firms to fail. The pace of benchmark rate hikes has left several banks with unrealised losses on their bond holdings. One such firm, Charles Schwab Corp., a brokerage giant and the 10th largest bank in the U.S., has lost 30.8% of its value this month, and lost $129.2bn in deposits in 2022.

Like SVB, several regional US banks including Charles Schwab took advantage of low interest rates to invest in long-term government bonds. The Federal funds target rate was at 0.00-0.25% between Dec-08 and Dec-15 in the fallout of the 2008 financial crisis. The Federal Reserve has since embarked on an unprecedented +475bps rate hike beginning Mar-22, bringing the Federal Funds Rate to 4.75-5.00% in its effort to tame inflation. This has lowered the market value of the bank’s bond holdings. Clients in turn moved their deposits to high-yield investments. For Charles Schwab, these unrealised losses amounted to $11.0bn on its hold-to-maturity bond portfolio by year-end 2022. Moreover, with the increased cost of funds, any attempts to raise additional capital at this time will hurt its earnings.

The high interest rate monetary environment can have detrimental consequences even beyond the banking sector. Although the Federal Reserve announced a new Bank Term Funding Program (BTFP) to make available additional funding to help assure banks’ capacity to safeguard deposits, it may be insufficient to stem the flow of funds from the sector. The growing stress on the sector boosts the odds of a US recession. Therefore, we expect the Fed to slow the pace of its rate hikes. Nonetheless, monetary authorities in Nigeria are inclined to keep interest rates elevated and implement other measures to defend the value of the Naira and keep Nigerian instruments attractive to foreign investors.