Silicon Valley Bank's Failure Exposes Financial Stability Risks

On March 10, California and federal banking regulators shut down Silicon Valley Bank (SVB) and seized its deposits, citing both illiquidity and insolvency. This is the 2^nd largest failure of a U.S. financial institution after Washington Mutual in 2008.

Although the bank specialised in banking for tech start-ups in the Silicon Valley area, SVB was estimated to be the 16^th largest commercial bank in the U.S. with about 209 billion USD in consolidated assets at the end of 2022.

While its collapse doesn't appear to be systemic, it highlights the impact of rate hikes on financial stability and the heightened risk in the US tech industry. The events are also a reminder that the impact of monetary tightening is still very much yet to come.

A failure attributed to an insufficiently diversified customer base, but also to the current monetary policy tightening

SVB specialised in banking services for the tech & biotech industries. During the pandemic, as California's tech industry experienced a boom, SVB saw a significant increase in deposits (+86% in 2021) and substantially invested in Treasuries and mortgage-backed securities.

This business model made SVB vulnerable to interest rate increases on two fronts:

• First, higher interest rates have hit its tech customer base particularly hard. It triggered a fall in venture capital funding and elevated cash burns among tech companies. This led to outflows of SVB clients funds in 2022.
• Second, as the Fed raised interest rates, the price of U.S. securities fell, squeezing SVB’s assets.

The deterioration of SVB's finances and the subsequent loss of its clients’ and investors’ confidence caused a run on the bank. On March 9, shares of the bank tumbled by about 60%. The same day, investors & depositors initiated withdrawals of about 42 billion USD. Subsequently, regulators had no choice but to shutter SVB. On March 12, authorities announced that all depositors would be protected and paid back in full, going beyond the guarantees that are normally provided by law.

The primary concern is the risk of contagion

For now, SVB's troubles appear more idiosyncratic than systemic, even though the Federal Deposit Insurance Corporation estimates that U.S. banks have 620 billion USD of unrealized losses. Large U.S. banks are much more diversified than SVB. The concerns are much greater over regional banks with similar profiles to SVB. Trading in stocks of several other banks, including First Republic Bank, PacWest Bancorp, and Signature Bank, was halted on March 10, and regulators announced they were closing Signature Bank, one of the main banks in the crypto industry, on March 12.

To stem contagion, US regulators announced a new emergency lending facility aimed at ensuring "that banks have the ability to meet the needs of all their depositors.” and stated they were prepared to address any liquidity pressures that may arise.

SVB's collapse highlights heightened risk in the US tech industry

Rising interest rates have eroded the easy access to capital that propelled start-up valuations and funded ambitious projects in recent years. In addition, the industry also had to contend with a decline in advertising revenue linked to a more challenging macroeconomic environment. All this has recently resulted in increased layoffs in the industry. We believe that higher interest rates and the disappearance of a major financing player could create additional turmoil for the U.S. tech industry.

A reinforced dilemma for central banks whose rates hike are just beginning to take effect

These events highlight a trilemma for the Fed: it needs to maintain price stability, promote maximum employment, and also ensure financial stability. The collapse of SVB contributed to a decline in investors’ bets on a 50 basis point hike at its March 21-22 meeting. The events are also a reminder that the impact of monetary tightening is still very much delayed, not only from a macroeconomic standpoint but also, and even more dangerously, from a financial point of view.

Read our Country Risk Assessment on the USA