'This time is different': SVB collapse symptom of easy money rather than systemic banking issues

The collapse of Silicon Valley Bank is not an early indicator of a 2008-style economic crisis, experts have said, instead arguing the fall of the institution is a symptom of the end of a period of "free-and-easy money".

While many have asked whether the largest bank failure since the Global Financial Crisis portends a second similar event, most argue the idiosyncratic nature of SVB's business is to blame for its collapse, rather than systemic issues in the banking situation.

This morning (13 March), HSBC bought the firm's UK arm, purchasing SVB UK for £1, along with all its liabilities, a move which had been brokered with the support of Chancellor Jeremy Hunt and Prime Minister Rishi Sunak. As a result, all depositors of SVB UK had access to their deposits and banking services restored, with no taxpayer support.

HSBC buys SVB UK as regulators back US deposits

In the US, regulators issued a new lending facility to ensure banks "have the ability to meet the needs of all their depositors", however Treasury secretary Janet Yellen has insisted there will be no bailout for SVB.

The move has resulted in the Federal Deposit Insurance Corporation making all depositors whole across SVB and also Signature bank, which collapsed late last night. Meanwhile a Bank Term Lending Program was established alongside the Fed's existing repo facility to provide loans at a 12 month duration, offering additional funding to any further banks that run into liquidity problems.

Alongside the direct impact, Neil Shearing, group chief economist at Capital Economics, noted the US action would hopefully maintain or restore the "confidence of depositors and investors in the US banking system".

‘Not a typical US bank'

One of the two key reasons "this time really should be different", according to Rupert Thompson, chief economist at Kingswood, is because of SVB's client base.

"The clue here is in the name," he said. "Silicon Valley Bank was very much focused on tech start-ups and ran into problems as the rise in interest rates had led to deposit withdrawals and was forcing it to sell its government bond holdings at a loss."

Capital Economics' Shearing explained the "unusually large proportion" of assets held in fixed income rather than loans was a core reason that created the "toxic mix", which caused the rapid decline.

"Crucially, once these assets were moved from SVB's banking book to its trading book it was forced to mark them to market, thereby realising losses caused by the aggressive rise in interest rates over the past year," he said. "These losses ultimately led to SVB becoming insolvent."

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Alongside the issues of SVB's client base and asset mix, a note from Algebris Investments highlighted the unique situation that allowed SVB to grow assets and deposits more than 200% over the past four years.

"Its business model focused on the venture capital ecosystem," the note explained. "The rapid expansion came at the cost of diversification, laying the foundation for much of today's issues."

More than this, the average US bank owned by Algebris holds almost two-thirds of deposit bases in insured accounts, compared with only 12% at SVB, which it described as "not a typical US bank".

A lack of diversification across clients and the assets backing deposits, both of which are extremely sensitive to rate changes, coupled with rapidly accelerating deposit outflows, left SVB "uniquely ill-prepared to survive the Federal Reserve's aggressive rate increases", according to Oxford Economics.

The end of ‘free-and-easy money'

Part of what led to such rapid deposit of outflows from SVB, as a result of increasing interest rates, is what Deutsche Bank head of global fundamental credit strategy Jim Reid described as a "symptom of a perfect storm".

"SVB's woes are a combination of one of the largest hiking cycles in history, one of the most inverted curves in history, one of the biggest bubbles in tech in history bursting, and the runaway growth of private capital," Reid explained.

Portfolio manager at Ninety One Iain Cunningham added that over the past 12 months there had been an exit from the "false equilibrium" that has spread in developed markets since the GFC.

"Policy makers have, for some time, set policy far too loose relative to prevailing economic fundamentals, evidenced by the material appreciation in asset prices over the period," he explained. "Policy makers have been willing to "pivot" or add stimulus at any sign of a wobble, seeking to minimise economic and market volatility.

"Such action has increased confidence and deeply embedded this false equilibrium in the decision-making processes of many households, corporations and even governments."

Cunningham described the "doubling down" of easy money both pre- and post-pandemic as the cause of inflation, which "broke the condition required to maintain the false equilibrium".

"The failure of SVB is a consequence of something much bigger and is likely to be the beginning of a broader delinquency, default and bankruptcy cycle rather than the end," he added.

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Russ Mould, AJ Bell investment director, also questioned how much further damage we are likely to see as "free-and-easy money" comes to an end.

He noted that businesses which had relied on "an artificially low cost of capital" are likely to "struggle, if not outright fail", while any survivors "may need to cut costs".

"The US move to protect SVB's depositors, and therefore fledgling tech firms' cash, will prevent immediate closures, but there are still likely to be casualties further down the road," he said. "The boom was even bigger in 2000-2021 and it now looks like the fall from grace will be all the harder this time."

Susannah Streeter, head of money and markets at Hargreaves Lansdown, summarised: "The era of cheap money has hurtled to an end and investors are waking up to some dramatic highly unintended consequences."

Success of 2008

While there may be further institutions "lurking in the shadows either in the US or other economies" that will be found "swimming naked" remains to be seen, as Shearing said, but several points allay the fears of systemic issues in the banker sector more widely.

Key to why ‘this time is different' is the strict regulation that was put in place post-GFC to ensure such an event would not happen again.

As Cunningham noted: "Many will remember from the global financial crisis that it was full deposit insurance that was ultimately required to halt deposit flight and, as a result, this action should stem the emergence of systemic risk for the time being."

Kingswood's Thompson added that not only were the problems faced by SVB "not applicable to the large banks, which do not face a run on their deposits and generally benefit, rather than suffer, from higher interest rates", the lack of a deep recession and stronger capitalisation of the large banks also assuage GFC fears.

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A further difference comes in the stringent regulation required of large banks versus the loose regulation at SVB, as noted by head of financials (credit) at Federated Hermes Filippo Alloatti.

"SVB was exempt from tight Basel 3 liquidity ratios and instead only mandated a quarterly liquidity report," he said. "Small banks like SVB can avoid taking negative mark-to-market on bonds portfolio against their CET1 [Common Equity Tier 1], artificially bolstering their solvency capital.

"However, when assets need to be sold for liquidity purposes, the loss goes straight to CET1, leading to a significant loss in solvency capital.

"Central banks have ample tools to support institutions with liquidity, including entire banking systems."

On the obverse, Algebris noted the regulatory requirements for European and large US banks.

"In Europe, banks are limited in how much rate mismatching they can take on their held-to-maturity bond portfolios, due to Basel 4 regulations," the firm said. "This means that they will not face the same steep negative equity position that SVB found itself in with its deeply underwater securities book.

"Further, European and large US banks must deduct unrealised losses on securities accounted at fair value from their regulatory capital."

Algebris also noted high diversification of European and large US banks, which means the probability of large withdrawals is "remote", while the strong liquidity management of these banks means they could still meet the large withdrawal requests if they came.

"In Europe, where deposits are still growing, banks are sitting on $3trn of excess liquidity representing about a quarter of the system's deposit base, and have an additional $1trn government securities market at fair value, as additional liquidity buffer."