SVB’s sudden collapse calls for more rigorous stress tests for banks

The wider impact of the US Fed’s rate-raising campaign on bank-held investments is hogging headlines
However, the question must be asked why regulators did not see Silicon Valley Bank’s demise coming

James David Spellman

Published: 1:30am, 15 Mar 2023

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The collapse of Silicon Valley Bank, the 16th-largest bank in the United States, underscores financial vulnerabilities as interest rates head steadily higher with the Federal Reserve’s determination to slash inflation by slowing the US economy.

A bank that took 40 years to reach its pinnacle as a key player in the ecosystem for start-ups disappeared in 36 hours, becoming the largest bank failure since the global financial crisis in 2008. The speed of events and the magnitude of the demise raise questions about potential tremors crippling the banking sector worldwide.

That there were signs of inevitable trouble a year ago is fuelling concerns about the quality and rigour of oversight.

SVB’s failure is easily explained. The bank had taken in about US$209 billion in assets and US175.4 billion in cash by the end of 2022 because its hi-tech clients were awash in cash as the pandemic unleashed unprecedented demand for technology infrastructure, from bandwidth expansion to network equipment and cloud services.

SVB ploughed the windfall into long-term, fixed-rate government-backed securities and Treasuries. This made sense at the time, as the Fed signalled then that interest rates would continue to be suppressed.

But in March 2022, Fed chairman Jerome Powell embarked on a vigorous campaign to rein in US inflation. The gap widened between what SVB paid to attract deposits and what it earned on interest.

US Fed chair Jerome Powell speaks at an event in Washington, DC, on February 7. Photo: Getty Images / TNS

Meanwhile, clients had been pulling cash from their SVB accounts as their stocks dropped in value when demand for their goods and services fizzled. CFOs needed cash since global venture capital funds had begun to fall – by 32 per cent in 2022 from the year before. CFOs also wanted higher returns than SVB was paying.

As withdrawals quickened, SVB was forced to sell its securities at a US$1.8 billion loss and raise cash through a US$1.75 billion stock sale. This news caused SVB shares to plummet last Thursday. Customers scrambled to pull out their money.

By Friday, California banking regulators closed the bank and appointed the Federal Deposit Insurance Corporation to dispose of the assets.

Two days earlier, Silvergate Capital Corporation, having been caught in the similar cash squeeze, announced it would voluntarily liquidate.

Only a small percentage of SVB deposits are insured, meaning its depositors could lose most of their funds. Roku, for example, said US$487 million of its US$1.9 billion in cash and cash equivalents were held at SVB. Other start-ups have reportedly sent notices to employees that they may not be able to pay wages. A generation of start-ups could be wiped out.

SVB’s reach extends to China, having been a means by which China-based start-ups raised funds in US dollars. Similarly, venture capital funds based in China saw SVB as a key partner. Limited information now makes it hard to gauge the liabilities and impact on their businesses ahead.

What is clear is that SVB’s collapse has sent shock waves through the venture capital markets and caused investors to downgrade their outlooks for banks worldwide, as seen in the fall of the S&P financial sector index, which was down 8.2 per cent for the week.

A First Republic Bank branch in New York is seen on March 10. The bank’s shares were halted after plunging by as much as 53 per cent last Friday as bank stocks are roiled by the fallout from SVB’s troubles. Photo: Bloomberg

Does this presage another global financial crisis? The events leading up to 2008 were very different. The bubble burst in US real estate. Mortgages were given freely, with little if any due diligence. Risks were hidden by financial engineering. Investment banks’ leverage was far too high. These were very different conditions from the ones today.

That the prospect of SVB’s demise for so obvious a reason went unnoticed has raised questions about regulators’ weaknesses. Why didn’t the concentration of investments in long-term government-based securities set off alarms? Was the fact that the investments were “risk-free” a cause for complacence? Was it another “black swan” or a more common prospect?

One top priority now for central bankers worldwide is to meet immediately to organise new stress tests to better understand the asset allocations of banks and the difficulties that may emerge as higher interest rates alter the value of bank-held investments and their returns. Current stress tests need a rethink.

Silicon Valley Bank fallout to unravel Chinese tech firms’ ties with US capital

SVB’s collapse has also called into question accounting rules. If risk-free investments are held to maturity, a company doesn’t have to mark those to market. So, SVB could carry on its financial statements the full value of the securities despite their fallen values if they had to be sold in today’s markets. However, when SVB began selling securities to raise cash, the bank was forced to mark the securities to market, compounding the troubles.

SVB’s demise has sounded the alarm about the broad impact of rising rates beyond the professed focus of Powell and his fellow governors. The speed and skill demonstrated over the next few days by regulators and central bankers to safeguard against future collapses will say much about how the likely troubles ahead will play out.

Assurances on Sunday by Treasury Secretary Janet Yellen offering help but not “bailouts” seems an unclear approach. But later, the Federal Reserve and Treasury used emergency authority to help ensure all depositors had access to their money on Monday.

The global financial crisis showed the need for governments to take swift, sure-footed actions. Fumbling undermines trust, the bedrock of financial markets, and fuels panic. In the first hours of this crisis, the lessons from 2008 have been well learned.

James David Spellman is principal of Strategic Communications LLC, a consulting firm based in Washington, DC