Is inflation good for the banks?

It depends on how fast is the inflation.

When interest rate is too low, it is hard for banks to charge more on loans. However, if the interest rate is raised too fast too high to fight inflation, it pushed a lot of potential customers out of the borrowing market. For example, mortgage rate is so high that many people can afford to borrow to buy a home.

I think that is playing out since the pandemic. Financials industry was doing quite well coming out of the pandemic because interest rates started to rise which has not happen for more than a decade. However, we see now Silicon Valley Bank just went bankrupt today.

It is very telling story. It might be unique to. SVB’s main clients are the tech startups which has been in a tough time due to high interest rates. They are capital intensive and take longer to turn profitable. Their future cash flow got discounted more due to high interest rates. That means they have less money to deposit in SVB and they need to take out money from SVB. However, SVB bought a lot of bonds when interest rates were low. Now, the interest rates are much high so the bond prices are much lower. They have to sell the bonds in a much lower price to make good of the customer’s withdrawals. That’s why they are in financial trouble.

The natural question is how contagious this is. Some says the big banks are fine. I guessed they are well-diversified in terms of their client base. As long as they are not forced to sell bonds at a loss, they should be fine.

That shows again how important diversification is. It is a way to spread and mitigate the risks.