When you consider the current banking crisis, it strikes me that the two US banks that have collapsed and been taken over, were, very active in the fund finance market. Subscription lines are such a small part of the overall credit market (0.177% of overall global debt) and there are much more risky credit books out there, it seems like coincidence.

Subscription line loans are a form of short-term financing that banks provide to private equity and venture capital funds, using the funds’ uncalled capital commitments from investors as collateral. These loans allow fund managers to bridge the timing gap between deal execution and capital call, and also enhance their internal rates of return by deferring the drawdown of equity.

However, subscription line loans are also exposed to the risk of rising interest rates, which can affect both the cost and availability of credit for both banks and funds.

• Higher interest rates can increase the funding costs for banks. This is because banks have to pay higher interest on their deposits and other sources of liquidity. For example, if a bank has a subscription line loan with an interest rate of 5% and the Federal Reserve raises interest rates by 25 basis points, the bank's funding cost for that loan will increase to 5.25%.
• Higher interest rates can reduce the demand for private equity and venture capital investments. This is because alternative assets, such as bonds and stocks, offer higher returns when interest rates are rising. As a result, investors may be less willing to invest in private equity and venture capital funds, which can make it more difficult for these funds to raise capital.

As a result of these risks, banks with large subscription line loan books are facing pressure from both sides: higher funding costs and lower asset quality. Some banks, such as Citigroup, are planning to reduce their exposure to subscription line loans in order to meet tough new capital rules imposed by the Federal Reserve. Others, such as SVB and First Republic Bank, have collapsed due to their reliance on these loans.

The collapse of SVB and First Republic is a warning to other banks with large subscription line loan books. These banks need to be aware of the risks associated with these loans and take steps to mitigate these risks. One way to do this is to hedge the interest rate risk on these loans. This can be done by entering into interest rate swaps or other financial derivatives.

Another way to mitigate the risk of these loans is to have a diversified loan portfolio. Banks need to find more innovative ways of doing this and two alternatives might be:

• To adopt loan products that respond differently to various economic events. For example, a bank can balance its exposure to interest rate risk by offering both fixed-rate and variable-rate loans, or hedge against credit risk by offering both secured and unsecured loans. By having loan products that are negatively correlated, a bank can reduce the volatility of its returns and improve its risk-adjusted performance.
• To expand the geographic and sectoral scope of lending. By granting loans to customers in different regions and industries, a bank can reduce its concentration risk and benefit from the growth opportunities in different markets. However, this strategy also requires more due diligence and monitoring by the bank, as it has to deal with different regulatory environments, cultural norms, and business cycles.

In conclusion, rising interest rates are impacting banks with large subscription line loan books by increasing their funding costs and reducing their asset quality. Banks may have to adjust their lending strategies and portfolios to cope with the changing market conditions and regulatory requirements. Private equity and venture capital funds may also have to explore alternative sources of financing or adjust their investment strategies and returns expectations.