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The collapse of the Silicon Valley Bank in the US was not surprising given the rate of monetary tightening following on the heels of a period of exceptional stimulus and it is unlikely to be the last.
Silicon Valley Bank was a state-chartered commercial bank with its headquarters in Santa Clara, California. It collapsed on 10 March, due to various reasons, including a lack of diversification and a classic bank run, where many customers withdrew their deposits simultaneously due to fears of the bank’s solvency.
“While we could not predict the exact circumstances of any particular crisis, the type of problems surrounding this bank are not wholly surprising,” says Sebastian Mullins, fund manager at Schroders.
The problems reflect a combination of factors including poor management (in this case a concentrated customer base in tech) and limited hedging of either loan or security risk which resulted in large unrealised losses as yields increased.
Mullins says these losses were then realised as assets were sold to fund the depositors who withdrew their funds. These losses extinguished the bank’s capital base.
“There was also regulatory failure regarding the smaller end of the US banking sector with total assets under $US250 billion that are not held to the same regulatory scrutiny and stress testing as the bigger banks.”
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The implications of monetary policy tightening and liquidity withdrawal was another factor.
“Policy tightening is designed to withdraw liquidity and re-price risk in the economy and business models that prospered in a free money or abundant liquidity environment were always likely to come under pressure.”
He points out that the Fed moved quickly to limit the contagion from the bank by guaranteeing depositors and announcing a term funding programme to ensure banks and other related institutions can meet their obligations to depositors and manage their liquidity requirements.
“They are keen to ensure the contagion to the broader banking sector is minimised and confidence in the US banking sector is restored. Avoiding a GFC repeat is paramount and these steps are positive and we hope effective over time. If not, more will likely be done.”
Andrew Williams, investment director for value equities at Schroders, says the collapse of the bank is certainly concerning for anyone invested in small US banks that have a material bias towards uninsured corporate depositors.
“The specific details of why and how the bank failed are important. The bank had a niche client base and was overwhelmingly skewed towards technology companies. It was indeed set up to do precisely this back in 1983.”
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Williams says in summary it appears that many of the issues are quite specific to the bank as a very narrow, US technology-focused lender.
“However, more generally, these events are a reminder that banks are businesses that critically depend on the confidence of depositors and investors. There are much larger capital buffers than in the past and liquidity regulation in Europe has been designed to limit the risks from deposit outflows and / or other funding shortages.”
He points out that a rapid loss of depositor confidence can still be a fatal shock for any bank.
“It is possible, we could see investors punish banks with undiversified client bases on the back of this collapse, especially where depositors are uninsured, such as non-retail.”