WEEKLY E-MAIL

20 March 2023

THE COLLAPSE OF SILICON VALLEY BANK

By Amelia Paullo

Silicon Valley Bank (SVB) was founded in 1983 and grew to become the 16th largest bank in the US by deposits, employing over 8500 people. SVB’s business was to primarily lend money to the Silicon Valley technology sector, with 10% of its loan book allocated to technology start-ups.

During the pandemic, SVB saw its deposits surge as technology companies profited from providing entertainment and delivery services to a population in lockdown. However, in 2022 SVB began to experience steep losses as the technology industry incurred a significant downturn and interest rates were rising aggressively.

SVB had been very good at obtaining deposits from Silicon Valley technology companies but not so good at lending its deposits out profitably. Instead, while interest rates were near zero, it simply invested funds raised from deposits in US government bonds and made a spread on the difference between customer deposit rates and the yield it was making on US government bonds.

SVB failed essentially due to poor interest rate risk management. As interest rates rose, the value of the US bonds it held fell sharply, wiping out the bank’s equity. As of 31st December 2022, SVB had unrealised losses of over US$15 billion on its US Bonds portfolio. A downgrade by a rating agency and a failed capital raising on 9th March 2023 spooked deposit holders, so much so that within 48 hours, enough funds had been withdrawn that the regulators had to be called in as the bank was facing a liquidity crunch. First, tech companies started withdrawing their large deposits, and soon after, hundreds of customers lined up in front of bank branches attempting to withdraw their deposits in a classic bank run.

SVB had assets worth US$209 billion, making it the most significant bank failure since 2008, albeit the bank accounts for less than 1% of total US banking system assets.

US bank regulators took possession of SVB on 10th March 2023, citing inadequate liquidity and insolvency. After a failed auction of the bank on 12th March, SVB assets were transferred to a new bridge bank, and a new CEO was appointed. The systemic risk designation of the bank allowed regulators to insure all deposits, but equity and bondholders will likely be wiped out completely.

Fortunately, a collapse like SVB is highly unlikely to occur in Australia. Australian banks do not have significant deposits sitting in Bonds, Mortgage-Backed Securities and other less liquid investments. The value of the securities on the SVB balance sheet was vulnerable to movements in interest rates.

Australian banks actually do what banks are supposed to do: lend money at a profit. They are intermediating between depositors and lenders, and the value of their assets (loans) move with interest rates as most loans are variable rate loans. Australian banks’ average deposits are also much smaller and stickier than SVB.

Fixed-rate mortgages can lead to mismatches between assets and liabilities, but banks usually offset this with two to three-year term deposits, and importantly the Australian Prudential Regulation Authority (APRA) imposes a capital charge for interest rate risk in the banking book. As rates have risen, Australian banks have been forced to set capital aside to cover interest rate risk.

Although fears of systemic risk in the banking sector have been calmed in the US with the Federal Reserve Bank (Fed) committed to providing funding to banks to meet the needs of depositors, the tight financial conditions due to successive interest rate rises means there will be lingering fears other banks may get into trouble. This may also prompt the Fed and Reserve Bank of Australia (RBA) to rethink their monetary policy strategies, reducing the probability of future interest rate hikes.

The RBA already looks to be much closer to the end of Australia’s tightening cycle than the US Fed, as the transmission of its monetary policy is more effective due to Australia’s prevalence of variable-rate home loans compared to the US, which has primarily fixed-rate loans.

Amelia Paullo
Financial Planner
Authorised Representative No. 1243426

If you have any questions or comments, please email me at amelia@gfmwealth.com.au

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