By now, we are all too familiar with the collapse of Silicon Valley Bank (SVB), and other banks like Signature and First Republic. With the 24-hour news cycle, you likely saw a flurry of financial experts speaking to the gravity of the situation. In fact, much of the news coverage maybe even reminded you of the 2008-2009 economic collapse that we now refer to as the Great Recession. That stretch of eighteen months or so saw one financial institution after another fail, despite the Federal Reserve providing false assurances along the way.
The question on so many investors’ minds today is whether this is 2008-2009 all over again. Or, is this moment in time notably different and hopefully more contained? Many pundits and government officials, including Treasury Secretary Janet Yellen, believe it is the latter.
Why Did Silicon Valley Bank Collapse?
SVB was truly an unusual bank, a unicorn of sorts. It catered primarily to Silicon Valley startups and venture capital firms and had very limited retail deposits (read: everyday investors). Indeed, SVB was deeply embedded in the U.S. startup scene, as it was the only publicly traded bank focused on Silicon Valley and tech startups.
Due to the economic slowdown, revenues for the bank’s main depositors, start-up technology firms, decreased. At the same time, due to rising interest rates, much of the venture capital funding that supported those firms also dried up. As a result, many of these firms started spending down their deposits to meet payroll and other obligations. This all added up to a perfect storm of sorts for these small startups, which desperately need liquidity in their early stages.
To meet these unanticipated withdrawals, SVB needed to sell some of its investments. They were forced to sell assets at a multibillion dollar loss to cover withdrawal requests, gathering attention from venture capital funds, many of whom subsequently advised their startup clients to get their money out of the bank. Hence the run on the bank, because most of these deposits were not FDIC insured. The FDIC said that depositors will be made whole, even if they were over the insurance limits, citing systemic risks as their rationale.
Although the closing of SVB is a tragic story, there are four key reasons why the collapse of SVB and other mid-size banks does not equal the collapse of the financial sector or the broader economy, as it did in the Great Recession of 2008-2009.
1. Banks are now more heavily regulated, particularly the larger, systemically critical ones
A key differentiating factor between the current crisis and that of 2008–09 is that the current regulatory backdrop is very different. Fifteen years ago, at the time of the Great Recession, banks were much less regulated, ran excessive leverage, and were poorly capitalized.
Looking at the large banks, they have faced a level of regulatory scrutiny that is orders of magnitude higher than in the run-up to the global financial crisis. Capital positions are stronger. Liquidity positions are stronger. It would be much more difficult for a mismatch between assets and liabilities or some kind of a concentrated position leading to a capital or liquidity event among the large banks.
Ironically, and demonstrating the point, it is the biggest U.S. banks—even as their share prices took a hit—that have been beneficiaries of SVB as customers sought a flight to safety with their deposits.
2. The quality of assets and collateral is stronger for banks
There is greater transparency over valuations today relative to the run-up to the global financial crisis. During the 2008 financial crisis, large institutions were the focus. Today the loan-to-deposit ratio for U.S. banks is at a multi-decade low, and capital ratios are at a three-decade high. It appears the large, systemically important institutions are doing what we hoped would happen when we tried to make the banking system stronger.
Today’s crisis is different. Indeed, as Erdoes says, “this crisis is about the smaller regional banks that don’t fall under the same guidelines and regulations as the large banks, and we’re seeing the consequences of that.” (Barrons, March 2023) We are hoping for regulations that will help regional banks think about risk management in the same way as the large institutions.
3. The Federal Reserve has instituted measures to shore up bank finances
In response to this crisis, the Federal Reserve has taken two actions. First, it instituted the Systemic Risk Exemption which allows it to guarantee deposits in the case of insolvencies of banks if they deem the insolvency creates systemic risk.
Second, the Federal Reserve also created a new lending facility called the BankTerm Funding Program, which banks can use to borrow cash in exchange for posting certain assets as collateral. In theory, banks could use that cash to cover deposit requests. The guarantee of the unsecured deposits may help contain immediate fallout, like companies that had money at SVB and Signature not being able to make payroll.
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