Maturity transformation refers to the process by which banks convert short-term customer deposits into long-term loans. The aim is to ensure that financial institutions have sufficient liquidity to make short-term payments to clients, while at the same time making long-term loans to companies and individuals. Banks generate profit from the risk they take on by offering long-term loans that generate higher interest rates than short-term deposits.
But what exactly are the risks that banks take on in this process?
There are three types of risks:
- Credit risks relate to the creditworthiness of counterparties with which a bank invests funds (on the asset side of the bank’s balance sheet), mainly borrowers or bond portfolios.
- Liquidity risks relate to the ability to service customer funds (which can be withdrawn at short notice) at all times, so that a bank has sufficient funds (including High Quality Liquidity Assets (HQLA)) at its disposal.
- Interest rate risks are concerned with the way in which a bank’s balance sheet and interest rate income reacts to changes in the interest rate environment.
Let us take a closer look at what happened at Silicon Valley Bank (SVB).
- In recent years, the bank received a great deal of client money and wanted to invest it profitably with a margin.
- It was for this reason that SVB purchased government bonds. Such bonds are very safe in terms of credit risk. From a liquidity point of view, they are also available at any time. The question is at what value, which brings us to the final risk.
- The interest rate risk was completely neglected, and no interest rate swaps were in place. This interest rate risk materialised, i.e. the treasury bond portfolio lost value as a result of the rise in interest rates, and it lost value substantially – to the extent of the entire equity of SVB. The bank was therefore effectively overindebted for several months. This was due to poor interest rate risk management and non-compliance with regulatory ratios such as the Liquidity Coverage Ratio (LCR) and the Net Stable Funding Ratio (NSFR). It needs to be mentioned that in the case of SVB these two requirements were not applicable (a story of its own). Once this news spread within social media (paired with the upcoming uncertainty related to fire sales of parts of the bond-portfolio) a bank run was inevitable. So, at the core of the story was bad interest rate risk management.
Ultimately, every bank is exposed to interest rate risks, and therefore needs to monitor and manage it, as well as comply with the existing regulations designed to mitigate that risk (IRRBB regulation).
As opposed to banks, Crypto Finance Group is not exposed to credit, liquidity, or interest rate risks.
On the one hand, a securities company and licensed asset manager such as Crypto Finance Group does not hold a loan book and therefore does not face the risks associated with maturity transformation. On the other hand, such a company is not funded by retail deposits, but predominantly by equity (mainly from Deutsche Börse, our majority shareholder). A bank run can therefore be ruled out as no customer funds are used to refinance the business.
Additionally, at Crypto Finance Group we always keep client assets segregated and do not lend, pledge, or otherwise take any action with respect to client assets that is not in the best interest of the clients themselves.
Read more about the latest developments in the financial sector here.