This past week was a week of shocks and market volatility. Early in the week, Federal Reserve (Fed) Chairman Jerome Powell stated that the Fed was prepared to speed up interest rate increases if the data warranted, and that the peak rate would be higher than previously anticipated. Markets took this as a willingness to hike rates by 50 basis points (bps) at the next policy meeting, if needed. Then on Friday, the Federal Deposit Insurance Corp. (FDIC) put Silicon Valley Bank (SVB) into receivership. The failure of SVB, fears of “higher for longer” from the Fed, and a general tightening of financial conditions were more than enough to offset another solid month of US employment gains, leading investors to fret that US economic growth might stall by year end.
Even worse, as large depositors realized that the FDIC was not prepared to insure its holdings at SVB, jitters spread over the weekend that other banks might experience depositor flight. Fears of bank runs prompted a significant policy response. Late Sunday afternoon, the US Treasury, Fed and the FDIC announced that all depositors of the failed SVB and a second bank failure, Signature Bank, a key bank to the cryptocurrency industry, will have access to all their money starting Monday, and that other measures would be taken to ensure adequate banking liquidity nationwide. Their aim is to prevent a single bank failure from becoming another financial crisis.
As this remains a fluid situation, I wanted to get out some preliminary thoughts. I will continue to update my commentary as the situation evolves.
- Accelerated outflows at SVB required the FDIC to step in. Like all banks, SVB had illiquid assets (loans) and liquid liabilities (deposits). As important segments of its depositor base (i.e., entrepreneurs) began to see their funding from other sources (e.g., venture capital) dry up, their need for cash forced them to withdraw deposits from SVB. To meet that demand for cash, SVB was forced to sell holdings of US Treasuries. Given the sharp rise in interest rates and fall in bond prices over the past year, those sales resulted in significant losses for SVB. When those losses were revealed to be nearly US$2 billion, deposit outflows accelerated, requiring the FDIC to step in, close the bank, and reopen it under a new name (National Bank of Santa Clara–NBSC).
- Share price of other US banks impacted. When it closed SVB on Friday, the FDIC has announced that deposits of US$250,000 or less would be guaranteed, but deposits of over US$250,000 would receive “certificates” whose value would depend on the recovery rate of SVB’s assets. That decision made large depositors at other US banks not designated as “systemically important banks” nervous, apparently resulting in the start of significant depositor withdrawals from many smaller banks nationwide. Investors, recognizing that risk, had already sold off shares of smaller and mid-sized banks—those most at risk—late last week. Meanwhile, for the technology sector, the potential losses of commercial depositors at SVB suffered were potentially significant, and risked putting added pressure on the tech sector, which has already suffered a slowing of activity and employment.
- Systemic risk was emerging. By this weekend, it was clear that what was originally thought to be an isolated bank failure posed a systemic risk to the financial system. That resulted in the aforementioned actions of the regulators to stabilize the situation. With respect to SVB, the FDIC will complete its resolution of the bank in a manner that fully protects all depositors. Simultaneously, with the approval of the US Treasury Department, the Fed will initiate a new Bank Term Funding Program aimed at providing adequate emergency funding to any bank suffering significant depositor withdrawals.