The investment implications of the Silicon Valley Bank failure
Markets have been shaken by the collapse of Silicon Valley Bank (SVB), the second largest banking failure in US history (and 16th largest bank in the US), following the decision from regulators to shut down the bank on Friday 10 March, on concerns over its liquidity and solvency.
SVB does stand out as relatively unique relative to its peers in the broader sector, largely in terms of its deposit base:
- 93%1 of deposits were from corporates (rather than a balanced mix of households and businesses). Of this, over 50% were concentrated in early-stage technologies. A downturn in access to venture capital investment in technology in the past year led these companies to call on deposits to fund ongoing business.
- 95% of SVB’s deposits exceeded the FDIC2 $250,000 limit and were thus uninsured. Such a high proportion of uninsured deposits meant that, unlike the average commercial bank, SVB was very vulnerable to a traditional bank run, which occurs when depositors – on mass – withdraw their money for fear that they won’t be able to get it later.
Following the decision from regulators to close SVB last Friday, the subsequent closure of Signature Bank – the 29th largest US bank and another institution with heavy exposure to the technology industry – added to investors’ concerns this weekend.
What happens next?
The fact that most depositors in SVB (and in Signature Bank) were corporates in the highly concentrated technology sector meant that SVB was naturally more vulnerable to capital flight.
Where SVB’s troubles could potentially impact the broader banking sector, however, is that SVB had invested its deposits in “high quality” bonds, including US Treasuries, which made losses last year that were unexpected and large relative to historical precedent. While SVB held a particularly large proportion of its portfolio in these bonds, all financial institutions have such assets on their balance sheets and thus are also potentially exposed to some unrealised losses. This is potentially a problem common to banks globally, which is one reason European financials are having similar difficulties to US financials today.
These unrealised losses don’t matter if the banks can hold their bonds to maturity and receive the par value of the bonds. The systemic risk to the financial system, therefore, comes from the possibility that depositors try to withdraw their funds on mass, forcing financial institutions to instead sell these assets and realise their losses. The result would turn a liquidity crisis into a solvency problem, with the potential for financial contagion.
The package of measures issued in a joint statement from the Federal Reserve (the Fed), FDIC and US Treasury seeks to short circuit this potential feedback loop at the outset via two mechanisms:
- All SVB and Signature Bank depositors will have their deposits returned in full.
- A new Bank Term Funding Program was established to ensure that depository institutions can deposit their high quality collateral at par, not at market value, sending a clear signal that banks will be able to use this facility to deposit collateral rather than sell at a realised loss.
In our view, these measures represent a comprehensive fire breaker, which should reassure depositors and negate the need to withdraw deposits, or transfer to other institutions or savings vehicles. But only time will tell whether depositors understand these measures and act accordingly, or are instead influenced by panic. Over the coming days we will be closely monitoring deposit movements in the US and elsewhere.
At the time of writing, risk assets remain volatile with global financials leading the decline in overall global benchmarks.
Government bonds are rallying on perceptions that SVB’s collapse will lead to a much more cautious approach from the Fed and other central banks. In our view it would be appropriate for the central banks to reassess their future policy path, and to do so would not ignore inflation risks. At the very least we may see commercial deposit rates rise as banks seek to encourage their depositors to sit tight, and for credit spreads to remain wider. In other words, interest rates in the real economy are likely to rise from here, even if the Fed opts for a more moderate path of rate hikes.
While it can be tempting to let emotions take hold on days where markets are falling precipitously, it’s worth remembering that sharp asset price declines are often met with the boldest policy responses. If market turmoil intensifies we would expect to hear more in the coming days from regulators and central banks in other regions in reaction to the Fed’s announcements. We’d also expect the central banks to signal that they are more hesitant about future rate increases, which could support sentiment if done in a timely manner.