Strategy Note /

EM investors are still ignoring lessons from Silicon Valley Bank's collapse

  • Emerging markets banks have underperformed in recent days but investors are not yet discriminating for duration risk

  • We highlight the EM banks whose capital is most exposed to any downward revaluation of their investment portfolios

  • Chilean and Brazilian names seem most exposed, plus Santander Mexico. In the Middle East we highlight QIB and FAB

EM investors are still ignoring lessons from Silicon Valley Bank's collapse
Rahul Shah
Rahul Shah

Head of Corporate & Thematic Research

Ayushi Gupta
Dhruv Madia
Tellimer Research
15 March 2023
Published byTellimer Research

Despite US regulators' efforts to contain the Silicon Valley Bank (SVB) crisis, global capital markets continue to be roiled by the fallout. In this note, we examine the EM banks most likely to be affected by the duration risk of their investment portfolios (see here for the implications for EM sovereigns). We also consider the equity market reaction over the past few days and identify some anomalous moves. While developed market banks are down heavily, EM banks have proven to be much more resilient. This may not be appropriate.

Banking sector performance in 2023

Where EM bank duration risk is most likely to be concentrated

Investment portfolios are typically the second-largest asset class on commercial banks' balance sheets (after customer loans), typically accounting for around 20% of total assets. Overwhelmingly, these are exposures to high-quality issuers (such as governments), so credit risk should be limited. Their purpose is to provide a mixture of yield and liquidity; the securities can be sold, or temporarily exchanged for cash at the central bank or other commercial banks via repo transactions.

The key issue that SVB highlighted is that, due to the sharp interest rate increases of the past few months, these bonds may be worth less than their carrying value on the balance sheet. Selling the bonds to release liquidity to honour deposit withdrawals could crystallise losses, in turn eroding the banks' capital ratios.

SVB is an exceptional case, in that the bank was suffering from sizeable deposit withdrawals from its tech/start-up heavy corporate client base. But in other respects, some emerging market banks could prove more vulnerable. Notably, monetary tightening in certain EMs has been much more aggressive than in the US, meaning the decline in bond values could be steeper.

Our initial analysis from last week highlighted certain banking systems that could prove more vulnerable to this risk. Regarding bank fundamentals, we focused on liquidity and capitalisation to build a simple SVB risk indicator. At the macro level, the key risk driver is the extent to which interest rates have been lifted from their Covid-era lows. On this basis, banks in the top-right quadrant of this chart could be considered as higher risk than those in the lower-left.

Emerging markets banks: SVB risk matrix

EM bank investors are still ignoring duration risk

We present below the one-week performance for components of the S&P500 index. Not surprisingly, banks have been by far the weakest sector. 

US banks have massively underperformed

Banks have also recently sold off in emerging markets but to a much less pronounced degree. What is surprising is that equity markets don't appear to be factoring in the impact of monetary tightening on banks' risk profiles. SVB only got into difficulty because rate hikes reduced the value of its bond investments. The amount of value diminution depends on two factors: the bond duration and the change in interest rates.

Banks in markets with limited rate increases (such as China) should be relatively immune from an SVB scenario, provided their investment portfolios are predominantly from domestic issuers. In contrast, banks in markets where interest rates have risen substantially are more at risk of investment portfolio valuation erosion. But when we look at recent share price performance, there is very little differentiation between markets that have hiked rates aggressively and those that have not.

EM bank performance has not tracked duration risk

Entity-level data highlights the Chilean and Brazilian banks

Given the above share price anomaly, we focus our attention on markets where policy interest rates have risen by 4% points or more since their Covid-era troughs (ie several Latin American and Middle Eastern markets, plus the Philippines). These are the markets where banks' investment portfolios could be most exposed to losses on disposal if their carrying values have not already been adequately marked to market.

For selected large-cap banks in these markets, we have examined their investment portfolios, in particular the portions that are carried at amortised cost (also known as 'held to maturity' investments) or valued at fair value through other comprehensive income ('available for sale'). For the latter, we note that these are typically level 2 assets, hence carrying values may not reflect their true realisable value.

For these two categories of investments, we assess how much they would need to fall in value for each bank's equity/assets ratio to decline below 6%. We do this for both categories combined, and solely for the AfS portfolio (since there are stricter rules governing the HtM portfolio, banks may find it harder to liquidate these positions).

Our results indicate that in Latin America, the Chilean and Brazilian banks have less room for manoeuvre than their Peruvian counterparts. What is particularly surprising is that Chilean bank shares have proved to be quite resilient over the past week, despite this being a market where monetary tightening has been severe, and where the banks have very limited wiggle room in relation to investment portfolio valuation adjustments. In the Middle East, some UAE banks are more exposed than their Saudi peers. 

EM banks' AfS and HtM investment portfolio risk


For selected large-cap banks in markets where interest rates have risen the most since their Covid-era lows, we present below the Trading, AfS and HtM investment portfolios of the banks, both as a percentage of assets and of equity.

EM banks' financial investment portfolios