The Collapse of SVB – a One Day Wonder or The First Domino?
It is a truism in stock markets that a significant market turn is triggered by an event which no-one is expecting. And so it was with collapse of Silicon Valley Bank. One would have justifiably believed that banks were a highly unlikely source of systemic or market risk since the virtual implosion of the global financial systems in 2008. Following those events, banking regulations were considerably hardened on both sides of the Atlantic and a commonly heard phrase in recent years has been ‘bank balance sheets have never been stronger’. While that may have been – and may still be – true in Europe and among the banking majors in the US, it does not appear to have been the case with second and third tier banks in the US. And it clearly was not the case with Silicon Valley Bank (SVB).
Apart from the assumptions about bank balance sheet strength, this environment of increased inflation and rising interest rates was supposed to be good for banks. Rising interest rates generally allow banks to widen their net interest margins as the gap between what they can charge for loans and what they need to pay for deposits gets stretched which of course is very good for profitability. This view was very evident in the sharp rise in the prices of bank shares over the past six months.
However, in a number of respects SVB was not a typical bank. As suggested by the name the bank positioned itself as the bank of choice for the burgeoning tech sector on the US West Coast. From there it spread across North America and as far as Europe, retaining its focus on the technology sector. Large numbers of tech companies placed their surplus cash flows with the bank but on the other side of the balance sheet the slowdown in the sector over the past three years meant fewer lending opportunities. As a result a growing volume of this surplus cash was invested in bonds. The sharp fall in bond markets in 2022 resulted in significant stresses on SVB’s balance sheet, in turn causing many of these bonds to be sold at a loss and eventually leading to the bank’s collapse.
The Federal Reserve has stepped in to guarantee all deposits held by SVB and this has stemmed the panic to a degree. However, other mid-sized US banks have experienced something of a run on deposits over the past couple of days and the contagion has also spread to Europe, although here the effect has been mainly on share prices. And it has not been confined to the banking sector as share prices across the board have fallen. It has even given central banks pause for thought and we may well see a slowing of the rate at which interest rates will be increased. So its to be expected that investors are asking is this an isolated event or is this the trigger for something bigger. While we are leaning towards the former as the stronger likelihood, the next few days and weeks will tell a story.
