March 16, 2023
10 implications for fintech of the SVB collapse
The sudden collapse of SVB continues to send reverberations throughout not just the fintech ecosystem, but also the broader financial markets.
While in many ways it feels too early to look back on what happened, we can nonetheless draw some conclusions about how the world has changed and how it will continue to change in the near future.
Here are 10 implications of the new world we live in.
The ending of the 40-year bull market in bonds will be a turbulent transition
A lot has been written about the end of the 40-year bull market in bonds that started in the early 1980s. A big driver behind this bull market was the macro economic impact of the demographic bubble represented by the baby boomers. Born right after the Second World War, this generation started entering their mid-thirties by the early 1980s, at which point they started accumulating capital at pace, which gradually but inevitably started putting downward pressure on real rates. Baby boomers are now entering their mid-70s, and rather than accumulating capital, they are now decumulating it.
This was clearly not the only driver behind low rates – globalization, technological improvements, and the emergence of developing countries all played major roles.
Whatever the causes, the bull market is now coming to an end, and as the SVB example painfully illustrated, the transition will be anything but smooth. They got caught on the wrong side of rate movements, and as confidence in their balance sheet collapsed, so did the bank, in a matter of hours.
Beyond SVB, considering debt to GDP ratios for sovereign countries also brings home the magnitude of the challenge that lies ahead. If a country has a debt to GDP ratio of 200%, a one percentage rise in interest rates, corresponds to 2% of GDP. As more income is diverted to debt service, budgets and consumption will shrink, with monumental consequences.
The perception of bonds will change
As rates go up, bond prices decline. And the longer the duration of the bond, the more severe the reduction. We will now start to adjust to a world where bonds are not necessarily seen as safe havens, or more specifically, will only be seen as safe havens in cases where they can be held to maturity.
For example, a bond with a 1% coupon and thirty year maturity, has a duration of about 25, which means that if the rates rise by 1%, the price of the bond would go down by about 25%.
As rates rise, the reality of this simple math will reverberate through world of finance.
The narrative around how to allocate your pensions will change
Over the last forty years, bonds yielded positive returns to holders as rates were going down. As this changes, bonds may very well return to more historical norms of close to zero real returns, or negative returns over short periods of time when rates increase rapidly.
This will have implications for how portfolios are constructed for the purposes of retirement and pensions.
Very likely, bonds will increasing be come to seen as a hedge against inflation, as opposed to a strategy for generating real returns. Inflation linked bonds that can lock in a real rate of return may also become more popular.
Banks will not be able to rely on income from bond portfolios the way they used to
As the SVB example illustrates, bonds will likely have lower real returns, and hence become a less reliable tool for generating excess income, on bank balance sheets or elsewhere.
As a result, banks will likely start favouring lending where they can pass rate rises onto consumers, and make excess returns.
Lending platforms that can pass on cost of debt and manage risk effectively will become more valuable
It follows from the above point that lending platforms that can generate low risk, high yield assets in a predictable and low yield fashion will become more valuable, and banks may in fact be willing to pay a premium to acquire such assets.
The Fed will have to make difficult trade-offs between inflation, financial stability, and unemployment and there may be no easy paths forward
The Fed will have very difficult trade-offs to make in the coming months, and will very likely have to choose between reducing inflation or creating more market volatility. It is impossible to say which way they will act, but there will likely be a stark trade-off between reducing inflation vs. avoiding future events akin to the SVB failure.
Protectionism and the roll-back of globalization may be a political response in many countries that ultimately has negative growth consequences
Times of turmoil lead to simple narratives, and unfortunately, many of those simple narratives involve protectionism and anti-immigrant sentiments, just to name a few.
Ironically, globalization, immigration, and trade are all forces that drive economic growth, and to the extent these are rolled back, growth will suffer further, potentially creating new challenges and reducing dynamism in the economy.
Bank consolidation will only gather pace
Flight to quality in deposits will likely be a real thing, and this, along will all prior forces around economies of scale, will continue to drive bank consolidation.
Modern finance is faster
The run on SVB happened at the speed Silicon Valley is used to, and it is fair to assume that this is the new gear modern finance will now operate at this moment henceforth.
Regulators will have to keep up with these challenges, and it is likely that the bank regulators globally will find ways to adapt, including the introduction of digital currencies.
Fintech is here to stay
Finally, all this change means that the impetus for innovation in financial services will only increase.
To adapt to this new world, we will need visionary and skilled entrepreneurs along with expert venture capitalists willing to back them in order to help solve the new challenges presented by the brave new world of tomorrow.