Silicon Valley Bank is a bust. With assets of $212bn and a market capitalization of $16bn as of Wednesday, it was the biggest bank failure since the global financial crisis. SVB is distancing itself from Silvergate, a small crypto bank that announced plans to shut down this week. Silvergate alone has $11bn in assets and operates in the financial gaming sector. SVB is a real bank and its collapse will have real economic consequences.
It is important to understand what the consequences are, instead of attributing the failure to bad debt, inadequate capital and the hidden interdependence that characterized the systemic crisis of 2008.
The SVB problem started with the investment boom that followed the start of the coronavirus pandemic. As a bank for venture capitalists and California startups, it overflowed with billions in deposits from young companies flushed with investor cash. There is so much money – almost $130bn in new deposits in 2020 and 2021 – that SVB cannot lend it all. Instead, they invest most of their money in long-term US government-backed bonds. Bonds have no credit risk, and since SVB’s deposits have almost no costs, they are also profitable, even if they only pay a certain percentage of interest.
But this balance sheet structure only works when rates stay low. As the Federal Reserve fights inflation and rates rise, deposits become more expensive. Last year, SVB’s deposit fees increased from 0.14 percent to 2.33 percent. Meanwhile, long-term government bond yields haven’t stopped. A profit squeeze was looming.
The bank plans to address the issue by selling some long-term bonds and reinvesting them in shorter maturities and higher yields. The loss on the sale will crystallize to be offset by new equity. But investors and depositors are not waiting to see if the plan will work. SVB shares and bonds were sold on Friday. That same day, depositors rushed to withdraw their money – up to $42bn in just 24 hours – forcing the Federal Deposit Insurance Corporation to step in.
In the past few years, many other banks received a wave of deposits and put the money in long bonds. Do they face the same fate as SVB? Perhaps, but SVB is an outlier in the banking industry, in three ways: its deposits are very sensitive to interest rates; the assets are not very sensitive; and its client base is unique.
A new report from RBC Capital Markets ranks the 100 largest US banks on various balance sheet characteristics. SVB is 99th in the proportion of deposits that are under $250,000, at less than 3 percent. That is important because large business deposits such as SVB are very price sensitive. They demand more interest when they see rates rise. Small retail savers are not bothered. Therefore direct pressure on SVB margins. In the proportion of total bank assets held in securities, on the other hand, SVB is first, at 55 percent. Most banks have floating rate loans that pay more when rates rise. No SVB.
Finally, SVB clients are also creatures of low rates. As Fed policy gets more accommodative and VC money flows in, start-ups are confident and flush with cash. Higher rates and technology sales have changed everything, making young companies jump in and squeeze money. When Bloomberg reported on Thursday that Founders Fund, a prominent VC fund, recommended that the company withdraw money from SVB, which could seal the fate of the bank.
Other banks’ portfolios of long-term government bonds will be a drag on margins for years to come. That was largely understood by analysts and investors before SVB collapsed, however. However, the failure may change the banking system. After the death of SVB, the depositors, their confidence shaken, may demand more interest for their deposits, reducing the bank’s margins. But this is a problem of profitability, rather than a threat to solvency in the style of the 2008 crisis.
It has been widely noted that this week’s events are the result of a year of very low rates. Be the same. In a more normal rate environment, banks will not increase the duration of their bond portfolios in the search for yield. If banks now have to be more conservative to protect their balance sheets, that will have consequences for credit creation and the economy.
The risk of contagion in the banking system appears to be limited. But at the end of each central bank rate hike cycle, there is a phase in which the financial system begins to break down. These ruptures, small or large, undermine investor and consumer confidence, increasing the likelihood of a recession. The failure of SVB did not announce another 2008, but marked the beginning of a phase of deterioration.
robert.armstrong@ft.com