Bank Run: An Update on Silicon Valley Bank & Signature Bank
You may have seen the article on Silicon Valley Bank (SVB) in the Market Observer last Friday. Since then, things have moved very quickly and on Friday, SVB, the 16th largest bank in the US by deposits, become the largest bank failure since Washington Mutual during the Global Financial Crisis.
Over the weekend, the Federal Deposit Insurance Corporation (FDIC) and California regulators stepped in, closed the bank, removed senior management, sought a buyer, found none, and worked with the Federal Reserve and Department of the Treasury to backstop depositors.
Of major concern was 89% of deposits at SVB are over the FDIC insurable threshold. There was very real concern this would mean companies would be unable to access their deposits for basic functions such as meeting payroll. However, late Sunday night US regulators eased the worst of these concerns by announcing new facilities to backstop deposits.
“After receiving a recommendation from the boards of the FDIC and the Federal Reserve, and consulting with the President, Secretary Yellen approved actions enabling the FDIC to complete its resolution of Silicon Valley Bank, Santa Clara, California, in a manner that fully protects all depositors. Depositors will have access to all of their money starting Monday, March 13. No losses associated with the resolution of Silicon Valley Bank will be borne by the taxpayer.
We are also announcing a similar systemic risk exception for Signature Bank, New York, New York, which was closed today by its state chartering authority. All depositors of this institution will be made whole. As with the resolution of Silicon Valley Bank, no losses will be borne by the taxpayer.”
– Joint Statement from Department of the Treasury, Federal Reserve, and FDIC
This is an excellent Q&A written in a very approachable manner answering the most pressing questions: Silicon Valley Bank: Why Did it Collapse and Is This the Start of a Banking Crisis?
From the above article, this appears to be the main cause behind SVB’s rapid failure:
“The seeds of its demise were sown when it invested heavily in long-dated US government bonds, including those backed by mortgages. These were, for all intents and purposes, as safe as houses.
But bonds have an inverse relationship with interest rates; when rates rise, bond prices fall. So when the Federal Reserve started to hike rates rapidly to combat inflation, SVB’s bond portfolio started to lose significant value.
If SVB were able to hold those bonds for a number of years until they mature, then it would receive its capital back. However, as economic conditions soured over the last year, with tech companies particularly affected, many of the bank’s customers started drawing on their deposits.
SVB didn’t have enough cash on hand, and so it started selling some of its bonds at steep losses, spooking investors and customers.
It took just 48 hours between the time it disclosed that it had sold the assets and its collapse.”
A Look at Bank Runs
Bank runs highlight the unique nature of the financial system where the main commodity being dealt in is trust. Depositors trust that when they need access to deposited funds, banks and regulators have worked together to ensure there will be no issues.
When rumours or data begin to trickle out that a bank might be in trouble, things can snowball very quickly. There is a positive feedback loop in which perceptions of weakness influence (and then greatly amplify) reality which then influence perceptions of weakness. This process is called "reflexivity" and is a conceptual framework developed by legendary investor George Soros.
Let’s take a quick look at how it works:
Depositors withdrawing funds causing liquidity to dry up is a great example of how in situations of uncertainty, the more certain the actions of individuals. Nassim Taleb, the author of The Black Swan, sums this up in a great anecdote: if you’re waiting at the airport ahead of a vacation, the more uncertain you are about the working condition of the plane you’re about to board, the more certain you are you won’t be boarding. If you’re uncertain of the financial footing of your bank, the more certain you are you’ll be asking for your money back.
This quick stepping in by regulators is an attempt to get ahead of any dreaded “contagion”. This is where the failing of one bank leads to the failure of others. The reflexive relationship is shown below and plays out very quickly. The statement released yesterday evening on SVB’s deposits being backstopped also included those of Signature Bank in New York which was closed earlier on Sunday.
What Does This Mean for Other Banks?
This morning, NBF’s Banking Analyst published a note on the impacts for Canadian Banks: Implications of SIVB & SBNY failures are both broad-based and specific.
As stated above, this situation is very fluid and fast moving. We’ll be sure to include relevant updates as they become available.