With the recent volatility unleashed due to the closure of Silicon Valley Bank (SVB) operations, we share a series of questions and answers with the information we have so far.
What happened to SVB?
On March 8, SVB, based on the U.S. West Coast, announced the need to sell its US$21bn Available for Sale Securities (AFS) portfolio, which led it to acknowledge a loss of US$1.8bn. At the same time, the bank planned to raise US$2.25bn by issuing common shares and convertible preferred shares to improve its liquidity position within its balance sheet. After this statement, in hours, the bank suffered a bank run (massive withdrawal of deposits), so California regulators had to intervene in the bank.
What is the market worried about?
Bank indices and shares of financial institutions worldwide have fallen sharply after the news of the closure of SVB, with uncertainty centering on whether this situation could be an idiosyncratic event from SVB or if there is a risk of relevant systematic transmission. At the moment, a couple of banks have been intervened, First Republic Bank and Signature Bank, also by bank runs since they maintained a high concentration in their depositors. At the time of writing, the information and the market do not point to a significant risk of contagion for this sector.
What did regulatory authorities announce over the weekend?
At an emergency meeting, U.S. financial regulators (Treasury Department, the Fed, and the Federal Deposit Insurance Corporation) assured all depositors on Sunday that their money is safe after SVB bankruptcy. In this context, the authorities emphasized that the bank’s depositors will have access to all their money as of Monday, March 13. The statement noted that taxpayers would not be liable for any losses associated with SVB’s resolution. Similarly, the Fed announced implementing a loan program for financial institutions affected by the collapse of SVB.
How does SVB’s situation compare to other banks?
SVB had a high concentration in emerging growth companies (start-ups and venture capital) in specific niches, focusing on the technology and healthcare industries. The boom in technology fundraising and the large number of Initial Public Offerings (IPOs) in the wake of the pandemic substantially accelerated SVB deposits. As the operating conditions of these types of companies deteriorated over the past year, SVB began to experience a more pronounced than expected withdrawal in its deposits. Therefore, the deposit base that the bank had did not function like traditional commercial banking. Another factor that influenced SVB’s fall was its high exposure to low-yielding Treasury and mortgage agency securities, leaving SVB vulnerable to market losses due to the sharp increase in rates last year.
Contrary to SVB, the largest capitalization banks that could pose greater systemic risk worldwide were subject to a broader review by their respective regulators in the wake of the pandemic and other regulatory changes over the past decade. Therefore, this type of bank has a healthy portfolio of deposits and diversification, distributed among retail, institutional, and wealth management deposits. This offers a relatively stable deposit base. They also hold significant positions in what is known as HQLA (High-quality liquid assets), usually in cash and short-lived government securities. Finally, under Basel III regulations, they operate with strict LCR (Liquidity coverage ratio). Banks must maintain this LCR ratio >100% (i.e., always have enough HQLA to fund money outflows in a 30-day stress period).
What implications could it have on monetary policy?
The SVB situation represents a different complexity component for the Fed’s following announcement, reflecting other consequences of tightening monetary policy. Following the Fed chairman’s aggressive stance ahead of his most recent congressional appearance, markets began pricing in a higher probability of a 50bp hike at the next meeting in March. However, these expectations subsequently fell with the news of SVB’s closing of operations, again considering an increase of 25bp and in which the FOMC (Federal Open Market Committee) members would have to prioritize financial stability for the excellent functioning of the banking system and markets.
Conclusion
While SVB implies the most significant failure of a U.S. bank in more than a decade, and events like this can trigger instability, the risk of a crisis may be limited, especially since large, systemically important banks do not share the same vulnerabilities of which SVB was subject. In addition, regulators have already taken measures to avoid further transmission, not to mention that the Fed may rethink its policy strategy in the coming months, prioritizing the smooth functioning of the financial system.
Banks’ LCR liquidity coverage ratios (%)
Source: Credit Suisse
SVB Deposit Mix at 3Q22
Source: Goldman Sachs