A new stock has begun. The passage of time feels different between holidays and weekdays. Now, let's return to our daily lives and focus on work.
This time, let's not go too far and start from 2008. It was an event that revealed how vulnerable liquidity risks were for financial institutions during the financial crisis. Reflecting on that period, filled with lessons, we need time to think about our future strategies.
In U.S. politics, it was recognized that liquidity risks for financial institutions stemmed from excessive asset holdings compared to capital. To solve this problem, the Dodd-Frank Act was enacted in 2010, introducing the Supplementary Leverage Ratio (SLR) as a leverage regulation.
The SLR regulation serves to outline the ratio of Tier 1 capital to total exposure of risk assets. Accordingly, deposit-taking financial institutions must maintain a minimum of 3%, and Global Systemically Important Banks (G-SIBs) with assets over $250 billion must maintain at least 6% SLR. The purpose of this regulation is to encourage institutions to build sufficient capital and to avoid excessive asset management relative to their capital.
However, with the outbreak of the COVID-19 pandemic in 2020, the demand for U.S. Treasury bonds temporarily plummeted. This kind of change had a significant impact on the overall financial market, necessitating deeper discussions about liquidity management and asset management. In this context, financial institutions urgently need to continuously strengthen their financial stability to reduce liquidity risks.
To maintain stable prices for U.S. Treasury bonds, financial institutions need to actively purchase them, but the SLR regulation poses a significant obstacle in this process. In this situation, in April 2020, the U.S. government implemented a policy to temporarily exclude U.S. Treasury bonds from the SLR denominator, allowing financial companies to hold Treasury bonds without worrying about their impact on the SLR ratio. Consequently, U.S. financial institutions began purchasing more Treasury bonds than in the past.
In particular, it was this policy that allowed smaller banks, which had not diversified their asset management methods, to join in on the purchase of Treasury bonds. However, the side effects of this change emerged three years later.
Bonds are essentially certificates of loaning money. This is similar to a promissory note, but the crucial difference is that this right can be easily bought and sold. However, the problem lies in the price at which it is traded, i.e., "at what price should one buy or sell?". For example, consider the case of purchasing a one-year bond for 10 million won at an interest rate of 2%. Upon maturity, the principal of 10 million won and interest of 200,000 won will be received together.
However, if suddenly, six months later, there is an urgent need for money, one may find themselves in a situation where they have to sell this bond. Since this is a one-year bond, one would need to wait only six more months to receive both principal and interest. Thus, one might decide they do not want to sell the bond at a low price. From the new buyer's perspective, since they can receive 200,000 won in interest after six months, it would be reasonable for both sides to trade at around 10,100,000 won, including the principal of 10 million won and six months of interest at 100,000 won.
However, if the issuance rate for new bonds has recently increased, the situation changes. For example, if the new bond interest rate has risen from 2% six months ago to 10% currently, the value of the existing 2% bond will drop. Given that new bonds can yield 10% interest, the existing bond that pays only 100,000 won after six months becomes unattractive to buyers.
Ultimately, in order to trade the existing 2% bond without either side suffering a loss, the price of the 10 million won bond must drop to around 9.6 million won. This demonstrates the general principle that when market interest rates rise, the price of existing bonds falls, and conversely, when interest rates fall, the price of existing bonds rises.
This principle applies not just to short-term bonds, but also to long-term bonds of 5, 10, and 30 years. If the held bonds are long-term, the losses incurred when interest rates rise could lead to potentially larger losses over 5, 10, or 30 years. Particularly, U.S. regional banks that had a lot of low-interest long-term bonds felt a more significant burden in this situation, with SVB Bank being a notable example.
Financial institutions hold bonds in two ways. One is the held-to-maturity method, while the other is the available-for-sale method. The held-to-maturity method keeps bonds until maturity and therefore does not evaluate price increases or decreases. This means they remain on the books at their original cost.
In contrast, the available-for-sale method entails actively trading bonds, which requires ongoing evaluation of the price fluctuations of those bonds to record gains and losses in the accounting books. In this situation, SVB Bank had included a significant amount of U.S. long-term Treasury bonds that were purchased during a low-interest period in its held-to-maturity portfolio. However, as interest rates rose, the evaluation losses for these U.S. Treasury bonds increased, but since they were classified as held-to-maturity, they were not reflected in the profit and loss.
The bank's primary business is to receive deposits and pursue interest differentials arising from loans. Thus, depending on the method of bond holding, a bank’s financial status and management strategy can vary, requiring thorough understanding.
SVB Bank had a characteristic where its loan-to-deposit ratio was only 31%. While this bank held a substantial amount of deposits, it was slow to convert them into loans, leading to investments in U.S. Treasury bonds and mortgage-backed securities (MBS).
Ultimately, it was in a situation where approximately 46% of its total deposits were managed in U.S. Treasury bonds and eligible MBS securities, that is, mortgage-backed securities. However, this strategy was severely impacted by the Federal Reserve's interest rate hikes, which significantly expanded the evaluation losses of the bonds.
This situation posed risk factors to the financial stability of SVB Bank. The bank's loan and investment strategies led to unexpected outcomes in an environment of rising interest rates. This case well illustrates how cautious financial institutions must be when managing their assets.
A particular fact spread, prompting some customers to rapidly withdraw their deposits. In the case of SVB Bank, 46% of its assets were tied up in held-to-maturity securities, and 31% were used for loans, leaving 77% of its total assets illiquid. In this situation, the increasing number of deposit withdrawal customers led to an even greater liquidity shortage.
Ultimately, a situation arose where they had to touch their held-to-maturity securities to pay deposits. Selling U.S. Treasury bonds resulted in unrealized losses, leading to a staggering net loss of $1.8 billion. The CEO of SVB Bank announced that to address this situation, they would seek to bolster capital by issuing shares. This led to a second bank run officially beginning.
In the past, such a large-scale bank run did not occur easily due to the slow dissemination of information, and customers had to physically visit the bank to withdraw their deposits. However, in modern society, information spreads rapidly, which means that such a situation could progress much faster.
Currently, we live in an age where we can easily conduct financial transactions through smartphones. However, behind this convenience lies potential risks. For instance, at SVB Bank, approximately $48 billion in deposits was withdrawn within two days. As a result, on the first day, stock prices fell over 60%, and on the second day, they plummeted again by 63%, ultimately leading to the bank's closure. Such incidents clearly illustrate the instability in the financial market.
The Federal Reserve and the Treasury were at a critical juncture. They were facing three major challenges, the first of which was to prevent U.S. startups and venture companies from going bankrupt due to lack of funds. As SVB is a major bank for Silicon Valley, nearly 95% of its customers were uninsured depositors.
This led to severe damage for startups and venture businesses. The second challenge was to stop the spread of bank runs, and the third challenge was to prevent financial institutions from selling U.S. Treasury bonds in large quantities. The Federal Reserve and Treasury had to exert every effort to address these issues. They were working hard on various fronts to maintain the stability of the U.S. financial system.
The Federal Reserve and the Treasury recently found a unique solution. They announced that the government would take responsibility for deposits exceeding the $250,000 insurance limit. This can be seen as a result of addressing the first two problems with financial resources.
To tackle the third issue, the Bank Term Funding Program (BTFP) introduced by the Federal Reserve is noteworthy. This program supports banks in borrowing funds for up to one year against U.S. Treasury bonds or qualified MBS. This approach encourages banks to pledge these securities to the Federal Reserve to secure funding, thereby avoiding losses from selling held-to-maturity securities as in the case of SVB Bank.
On the surface, this may seem like a familiar and natural measure, but beneath it lies important details. When the Federal Reserve accepts U.S. Treasury bonds as collateral, it has decided to recognize the collateral's value at face value, not at market price. Thus, even if the market value of a $5 million apartment has fallen to $3 million, one could still borrow against it based on the $5 million standard. These details reveal the potential risks in volatile financial markets and the possibilities for resolution.
Ultimately, these measures are expected to enhance the stability of the financial system and have a positive impact on the overall economy.
The United States and the Federal Reserve, as the only country that issues dollars, have the ability to take unique actions in urgent situations. Recently, these emergency measures were accompanied by various countermeasures to prevent recurrence.
The special policy regarding U.S. Treasury bonds, introduced as part of the response to COVID-19, has now ended. This policy was a temporary measure to exclude Treasury bonds from the calculation of SLR.
As time has passed, changes have also occurred in U.S. economic policy with the inauguration of President Trump. These series of processes are having significant impacts on the U.S. financial system and economy.
Scott Bentsen, the Treasury Secretary appointed by President Trump, recently expressed, "President Trump and I are focused on the interest rate of the 10-year Treasury bond." This signifies not a pressure on the Federal Reserve to lower the benchmark interest rate but an intention to lower the U.S. 10-year Treasury yield.
In relation to U.S. Treasury yields, the principle of scarcity commonly applies. To raise Treasury bond prices, the bonds need to be made scarce, which requires reducing issuance or increasing the demand for purchasing Treasury bonds. However, the U.S. is currently facing a significant budget deficit, making it difficult to reduce issuance of Treasury bonds.
For this reason, the U.S. Treasury has no choice but to increase demand to buy T-bonds. Accordingly, changing SLR regulations can positively impact the increase in Treasury bond demand. If the SLR regulations are eased to the levels of 2020, U.S. banks might start purchasing Treasury bonds as actively as before.
If such a strategy is implemented, it could help alleviate the U.S. budget deficit issue and simultaneously stabilize the Treasury bond market. The potential impact of these changes on the financial market in the future is regarded as noteworthy.
Trump made critical remarks about the Federal Reserve's bank regulation on January 30, 2025. He said, "The Federal Reserve has taken insufficient measures on bank regulations," signaling that the Treasury would lead unnecessary regulatory reductions. One can see that preparatory work for the realization of this statement has already begun.
In particular, Michael Barr, the former Treasury Secretary during the Obama administration and currently the deputy chair of the Federal Reserve, has shown a strong willingness regarding SLR regulations. He is in charge of financial supervision, was appointed by the Biden administration, and has continually demanded that banks improve their capital soundness. However, Michael Barr announced that he plans to resign from his position in financial supervision on February 28, 2025. This essentially removes an obstacle regarding the regulation.
Trump is notable for his policy of imposing tariffs on several countries, and in this situation, the easing of SLR regulations could act as a factor that distracts from his focus. After a successor deputy chair aligned with Trump's preferences is appointed, there is a possibility that SLR regulations will be eased at an appropriate time.
Trump and the Treasury Secretary view lowering the 10-year Treasury bond yield as their primary concern. They are formulating strategies to encourage various countries to buy more U.S. Treasury bonds by suspending tariffs. Additionally, by easing SLR regulations, they aim to allow U.S. financial institutions to increase their holdings of Treasury bonds, preparing to lower the 10-year yields in multiple ways.
These series of strategies are expected to have a significant impact on the stability of the U.S. economy and interest rate policies and will play a vital role in the policy-making processes of the Treasury and the Federal Reserve.
