Silicon Valley Bank (SVB), the go-to bank for venture capitalists and start-ups, has collapsed with $212bn in assets and a market capitalisation of $16bn as recently as Wednesday. This is by far the biggest bank failure since the global financial crisis. SVB's collapse is not the same as the bad lending, inadequate capital and hidden interdependencies that characterised the systemic crisis in 2008. It began with the investment boom that followed the start of the coronavirus pandemic. The bank was flooded with billions of deposits from young companies flush with investors’ cash. They invested much of the money in long-term US government-backed bonds, which were profitable because SVB’s deposits cost almost nothing. However, this balance sheet structure could only work while rates remained low. As rates rose, deposits became more expensive, causing a profit squeeze.
The bank planned to solve the problem by selling some long-term bonds and reinvesting at shorter maturities and higher yields. The losses such a sale would crystallise would be repaired with new equity. But investors and depositors did not wait to see if the plan would work. SVB shares and bonds sold off on Thursday. The same day, depositors rushed to pull their money—amounting to $42bn in just 24 hours—forcing the Federal Deposit Insurance Corporation to step in.
In the past few years, many other banks received waves of deposits and put the money to work in long bonds. Could they face the same fate as SVB? Possibly, but SVB was an outlier in the banking industry in three ways. Firstly, its deposits were unusually sensitive to interest rates, and its assets were unusually insensitive. Secondly, its client base was unique. When Fed policy was accommodative and the VC money was flowing, start-ups were confident and flush with cash. Higher rates and the tech sell-off have changed all that, leaving young companies jumpy and tight with their money. Finally, SVB's proportion of total bank assets held in securities was first, at 55 per cent.
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 fell apart, however. Its failure may have changed things in the banking system. After SVB’s demise, depositors, their confidence shaken, may demand more interest for their deposits, squeezing banks’ margins. But this is a profitability problem, rather than a threat to solvency in the style of the 2008 crisis.
The risk of contagion within the banking system appears to be limited. But at the end of every central bank rate-increase cycle, there comes a phase where things in the financial system begin to break. These breakages, minor or major, erode the confidence of investors and consumers, increasing the odds of recessions. The failure of SVB does not herald another 2008, but it does mark the beginning of the breakage phase.