Investments | 15 March 2023
SILICON VALLEY BANK COLLAPSE SHOULDN’T CAUSE SYSTEMIC SHOCK
The banking sector was shaken by the fall of the start-up focused bank, but we don’t see it developing into a crisis.
The collapse of Silicon Valley Bank (SVB Financial) on Thursday (9 March) has hit headlines and markets but is unlikely to cause a systemic shock.
SVB had a very non-diversified business model compared to other banks. Most of its deposits came from corporates and start-up companies, that had cash but limited need for credit.
By contrast, larger, systemically important banks, which are under far greater regulatory scrutiny, don’t have the same concentrated levels of deposits or exposure to one area.
Since SVB’s collapse, we’ve seen further turbulence and questions around the situation of large banks in Europe. We think solvency concerns for large banks are exaggerated though. While there will be profitability implications for the banking sector as a whole, large European banks have strong liquidity and are stress tested regularly for scenarios such as rising interest rates.
Authorities act fast
The US authorities acted quickly to nip any potential contagion from SVB’s collapse in the bud. A package of measures has already been announced by the US Federal Reserve (Fed), Federal Deposit Insurance Corporation and US Treasury which includes all SVB depositors getting their money back.
Sven Balzer, Head of Investment Strategy at Coutts, says: “The SVB insolvency did hit markets and investors very abruptly, and at incredible speed, which led to equally quick market reactions. Risk assets were sold and government bonds bought. But the US authorities are fortunately reacting swiftly as they seek to counter the deposit loss dynamic in regional banks.
“The interventions announced by those authorities to protect all SVB depositors should help the risk environment and limit potential contagion, while the announcement that HSBC will buy SVB UK should provide some reassurance to the UK banking sector.”
He adds: “It’s important to put SVB into context. Its business model and balance sheet risk management stood out amongst its peers.”
Fed may now pause interest rate rises
Attention now turns to the Fed and how this may impact its policy of raising interest rates to tackle higher inflation.
Before SVB’s collapse, markets had readjusted their expectations around interest rate hikes, predicting that the Fed could raise them more aggressively than initially expected on the back of potentially sticky inflation. Even a 0.5% rate hike was not considered out of the question at the announcement due next week.
But now, this looks less certain and the Fed may consider pausing rate hikes in March to let financial markets adjust to the new situation. What we’ve seen over the past few days adds to ongoing uncertainty around inflation and interest rates, which in turn has sent bond prices higher (yields have fallen).
Sven says, “Markets will need some time to fully understand the US authorities’ new measures and feel comfortable with them. It’s also unclear to what extent this episode could impact consumer or business sentiment. The Fed may take these points into account even if the latest inflation trends still support their originally planned rate hike.”
What happened with SVB and could it impact the broader banking sector?
Rising interest rates, which actually fuelled a rally in banking stocks recently, negatively hit SVB because many customers withdrew their deposits. They either needed the cash, or wanted to invest it elsewhere to seek higher yields.
This forced SVB to sell some of its own securities to preserve its liquidity. The problem is, rising rates have hit the value of many of those securities – mainly high quality fixed income – and the bank had to sell them at a loss. A plan to raise capital then fell through, leading to its shares being sold off fast.
One point that has impacted the wider banking sector is that SVB is not unique in recording losses on such securities. The risk to other banks could be if depositors withdraw their money on a large scale, forcing them to sell their assets at a loss too.
But the US authorities are looking to address this issue within their recent package of measures, mainly by allowing banks to use these securities as collateral instead of selling them at a loss.
Past performance should not be taken as a guide to future performance. The value of investments, and the income from them, can fall as well as rise and you may not get back what you put in. You should continue to hold cash for your short-term needs.
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