A deeper look into the collapse of Silicon Valley Bank
Central U.S. monetary and financial policies led to the demise of SVB. They sparked vulnerabilities within the entire global banking system, but a recession is not to be feared for now.
Four decades after its creation, the Silicon Valley Bank (SVB) was the 16th largest bank in the United States. But earlier this month it collapsed in just 36 hours, as a dramatic bank run led to depositors withdrawing 42 $B on the 9th of March 2023 alone. This sent shockwaves through the international financial system. While spectators have been debating whether these March bank collapses will result in a recession in 2023, there is reason to believe such drastic effects will be kept at bay, at least for the time being.
What led to SVB’s collapse?
First, the nature of loans and deposits held at SVB are highly risky. Start-ups are the principal owners of these assets, and lending or borrowing from start-ups is often risky since they are likely to fail and not be able to pay back loans. Moreover, these start-ups are mainly from the tech industry, a sector where higher interest rates heavily affect success. In addition, 97% of the value of SVB deposits were uninsured by the federal government. This means that the bank’s customers have much more unstable behaviour, since they are more likely to rapidly withdraw deposits at the first signs of problems. All these high-risk aspects of SVB’s business meant the bank needed efficient and responsive asset and liability management systems to reduce its exposure to vulnerability. Yet, the bank did not have a Chief Risk Officer from April to December 2022. This made the bank extremely vulnerable since its risky assets were being mismanaged.
This mismanagement received limited oversight from federal law. A designated culprit for this is a 2018 Trump administration law that cancelled parts of the post-2008 Dodd-Frank credit regulations. Banks with assets lower than 250$B, including SVB, were now excluded from a significant portion of bank oversight. This lack of regulation is what enabled the SVB to expose itself to the vulnerabilities mentioned above, without being called into question by regulators.
The third overarching reason for the bank run on March 10th is inflation and high interest rates. During the pandemic, business deposits grew, flooding banks like the SVB with cash. SVB Financial then used these deposits to massively buy long-term U.S. treasuries at near-zero interest rates. The problem is that in 2022, the Fed increased interest rates to combat rising inflation, meaning the demand for bonds dropped, decreasing their price. Soon, SVB’s stockpiled bonds were worth 17$B less than their fair value. In conjunction with this, as interest rates rise, deposits fall, meaning firms seek to take some of the money they deposited out of the bank. To cover this fall in deposits, SVB announced on March 8th that it had sold a large portion of its securities and incurred a 1.8$B after-tax loss. This sparked fear that the bank was not doing well, which caused the bank to run on March 10th, and the SVB’s subsequent 160$B loss in value in 24 hours.
Is a global banking crisis to fear, or is the easing of created anxieties possible?
After SVB’s collapse, many feared contagion. Some of these fears materialised, as two days after the SVB collapsed, another mid-sized American Bank, Signature Bank, met the same fate. As nervous investors removed more than 10$B in deposits, banking officials announced the bank would be shut down. On the other side of the Atlantic, Credit Suisse also experienced a major slump in shares, sparking fears this crisis was not a U.S.-contained issue. As this risk of contagion took its footing in reality, analysts raised their predictions for chances of a recession in 2023, notably with Goldman Sachs raising these odds to 35%.
Yet, it appears unlikely that this contagion will spread much further. Reactions by relevant governmental and private actors have proved fundamental to easing anxiety. By setting up a bridge bank for SVB, the Federal Deposit Insurance Corporation has ensured that even uninsured deposits will be repaid. Signature Bank has also stated that all deposits will be reimbursed through a similar process and that not all deposits were at risk. Furthermore, when another bank, First Republic, saw its value beginning to spiral last week, the U.S. government helped organise an industry bailout with Wall Street giants agreeing to prop up the struggling bank. Therefore, adequate action by regulators has allowed, as a former top Fed economist put it, to “stomp out” contagion.
Financial stresses have also eased as regulators have announced reforms in the wake of this disaster. Fed officials could consider tightening rules for middle-sized banks, which could include banks with 100$B to 250$B in assets needing to hold more capital when the market price of their bond holdings drops. Other regulations are expected to be announced as the Fed's regulatory discrepancies have been criticised as important contributors to the crisis. While we may have to wait a little longer for these to materialise, for now, these projects have helped calm shareholders in understanding that their deposits are not indefinitely at risk.
Only days after its collapse, the SVB was hit with several shareholder lawsuits and an investigation from the Fed. These are investigating the potential misconduct of SVB officers, notably regarding the violation of trading rules. Such harsh penalties faced by the SVB should motivate banks that are knowingly engaging in risk-prone behaviour to modify this, further easing lender anxiety. Banks could also change their lending standards in order to shore up their finances, making it harder for businesses to get loans, further minimising risks.
Therefore, risks of a forthcoming recession have been duly obstructed, at least for now.
Written by Victoria Sabran