The sudden demise of Silicon Valley Bank (SVB) is the largest bank failure since the great financial crash.
The largest, but not the only one. In fact, SVB is not the only bank failure in March. Silvergate Capital and Signature Bank both went under in the same week as SVB. Both were heavily involved in lending to cryptocurrency firms, while SVB held the cash of nearly half of US venture-backed startup companies.
Despite swift government intervention to calm markets, banks around the world are feeling the after effects with large-scale sell-offs of bank equities in particular spreading to Europe.
While overexposure to crypto and early-stage tech has contributed to the demise of SVB, the macroeconomic environment is also a major factor. The global economy has been pummelled by a once-in-a-century pandemic, the war in Europe, and an escalating climate crisis. Rocketing inflation has led to interest rate hikes as central banks slam the brakes on spending.
It looks like a perfect economic storm, and for those who remember 2008, the collapse of SVB et al looks worryingly familiar. So how concerned should we be?
SVB’s collapse was sudden and spectacular, but not entirely out of the blue. The US Federal Reserve (Fed) has raised interest rates eight times since March 2022 in order to stamp out inflation.
The inevitable effect of aggressive monetary tightening is higher funding costs for banks. At the same time, the bank’s US bond portfolio lost value as rates rose. Selling off securities at a loss was a big red flag that markets could hardly miss. Panic ensued, and the rest is history.
“Reining in inflation is the Fed’s central goal and its hawkish stance made clear that it will likely come at an economic cost. SVB’s demise is an example of the increasing risks of the high-interest rate environment, but it’s limited to the financial sector, not the real economy.”
Dana Bodnar, Economist, Atradius
So what's the outlook for further interest rate rises by the Fed?
“Though inflation is declining, core inflation is not. Meanwhile, the economy continues to show strength. We continue to expect the Fed to increase interest rates further but the latest bout of financial volatility will encourage it to limit the hike to 25 basis points, as was the case in February,” says Dana.
Is it safe? Despite government guarantees, the markets are nervous and it is still not clear whether wide-scale contagion has been avoided.
In 2008, that kind of contagion left the global financial sector teetering on the brink. In the US we see small to mid-sized regional US banks are already suffering as customers move funds to (supposedly) safer havens. Trading in First Republic Bank and PacWest Bancorp was temporarily suspended this week after share prices plunged. In Europe, we see sell-offs of bank equities, and depressing prices.
Considering the speed at which SVB collapsed, Aaron Rutstein director of Risk Services for Atradius USMCA says “This is the 1930s dropped into the 2020s. Overlay Twitter on top of it and it’s a classic bank run on steroids because the technology can make it happen much more quickly.”
But, while these are worrying signs, we do not fear a repeat of 2008.
While the eras share similarities, there are also fundamental differences. US and European banks were forced to hold more capital after 2008, making them less vulnerable to liquidity shocks.
These reforms have ensured that banks’ balance sheets are in much better shape now than 15 years ago, preventing another similar credit crunch. Small- to medium-sized banks are not subject to the same level of regulatory scrutiny as the systemically important banks are which likely contributed to SVB’s collapse.
SVB was uniquely exposed to the startup tech sector. The other victims, Silvergate and Signature, are considered niche players.
With that in mind, Dana expects this current storm to pass. “We expect concerns to settle as confidence is restored, both by the Government’s liquidity support measures as well as implicit guarantees, and evidence that contagion is not affecting systemically important banks,” she says.
But choppy waters are still ahead and policymakers must continue to closely monitor banks’ balance sheets as they continue raising interest rates. Financial market contagion has spread globally but the banking sectors in both the US and Europe are in good shape to withstand higher rates.
“While the crisis at Credit Suisse appears to be the culmination of prior scandals and idiosyncratic issues, the largest bank sell-offs outside the US have been in the eurozone,” says Dana. “Losses have been greatest in countries that have suffered banking crises since the global financial crisis. But these appear to be legacy jitters as opposed to signs of systemic risks.”
The eurozone banking sector has significantly stronger capital and liquidity positions today than in 2008, underpinned by robust ECB supervisory infrastructure. In the face of higher market volatility, the ECB moved forward with a 50 bps hike on March 16. But policymakers now have the more difficult task to balance rising financial risks on top of economic slowdowns as they fight to control inflation.
So what do we expect for the wider US economy? Business never completely avoids the aftershocks of a banking failure.
The biggest disruption will be in Silicon Valley. SVB’s demise will choke off a major revenue stream for startups. Businesses that are pre-revenue, or making heavy losses in the expectation of profits further down the line, will find lines of credit restricted. Larger tech players are less likely to be affected.
A side note here is that the days of a venture capital model that has funded so many early-stage tech businesses over the last decade looks to be over. Funding is much easier to provide when money costs nothing, but we are not in that world anymore.
From Silicon Valley, the ripples will spread. When banks are faced with a liquidity squeeze they lend less money. Access to capital - already expensive due to high-interest rates - will tighten further.
“You can already see that companies needing to refinance their debt are doing so at much higher rates,” says Aaron.
Higher rates eat into margins. “Companies will be faced with either passing on the costs in higher prices - which is inflationary - or swallowing them which will impair profitability,” he adds. “It’s one or the other.”
Highly leveraged businesses in any sector may be hit, but companies that rely on consumer financing for big-ticket items will face a double whammy of rising costs and a shrinking market. Think automotive, housing, and eventually non-essential retail, as stretched consumers focus more on needs and less on wants.
“The effects of rate tightening have a lag of between 6 and 12 months so this may not be the end of the effects of recent strong tightening measures by the Fed,” says Aaron.
However, many sectors are performing well, including pharma, chemicals, oil and gas, commodities, and metals. In fact, the Fed is unlikely to reverse its hawkish monetary policy precisely because of the positive nature of economic indicators. The US economy has momentum.
Still, the glimmer of good news here is that a systemic banking crisis is highly unlikely despite bank stocks coming under pressure around the world. Caution appears to be the watchword here.