Silicon Valley Bank’s failure shines light on dangers lurking in higher interest rates

Silicon Valley Bank’s failure on Friday was an extreme consequence of broad trends squeezing profits and clouding the outlook for the banking sector.

SVB had grown to about $209bn in assets with a client base concentrated among tech and healthcare start-ups. This business proved particularly vulnerable to the impact of rapidly rising interest rates.

When its tech-focused depositors were hit by a cash squeeze driven by the recent downturn in the sector, they pulled money from their accounts to spend or move in search of higher yields. To help cover the withdrawals, SVB sold bonds in its portfolio. It also sold bonds to buy assets with higher yields.

But the bonds it was selling had dropped in value because of rising rates, crystallising huge losses. That worried customers of SVB, where 96 per cent of assets were held in accounts that exceeded the Federal Deposit Insurance Corporation’s $250,000 cap on deposit insurance — so they pulled even more money. The regulator announced it was closing down SVB on Friday in the largest bank failure since the global financial crisis of 2008.

Concern that other lenders might be caught in a similar spiral weighed on the share prices of global banks on Thursday and Friday and forced trading halts in the stocks of US regional banks that superficially resembled the California lender.

However, analysts and industry participants say SVB is an extreme outlier in an industry that is generally much more stable and better funded than before the crisis.

“I don’t think this is 2008,” said Sheila Bair, who ran the FDIC during the crisis. But she called the failure “an important reminder that banks heavily reliant on uninsured deposits can be subject to bank runs [and] financial assets, even supposedly safe Treasury securities, lose value when interest rates rise.”

For most banks, the pressures that drove SVB out of business are expected to cut into profits, making them less attractive to investors in the short term, but do not threaten their underlying solvency, analysts said.

“This will accelerate a growing war for deposits and crimp bank earnings as they pay up for funding,” said Huw van Steenis, vice-chair of Oliver Wyman, which advises banks.

Last year, banks enjoyed substantial boosts to profits from what is known as net interest income, or the difference between the amount of interest they pay to depositors and the revenue they receive from making loans. Most banks raised the interest rates they charged on loans while still paying next to nothing on deposits.

But savvy customers are moving their money into other products such as money market funds and short-dated bonds. Banks have been telling investors to expect outflows of 2 to 4 per cent annually, according to Autonomous Research. This effect is particularly pronounced among the large corporate clients that SVB relied on.

The failed lender’s $1.8bn in losses on bond sales also highlighted another widely shared problem: many banks have parked depositor money in fixed-rate government bonds that have lost value because of the rapid rise in interest rates. The FDIC recently reported that US banks are sitting on $620bn of combined unrealised losses in their securities portfolios.

SVB got most of its funding from deposits and had more than 50 per cent of its assets in securities, so it had to sell some to give depositors back their money. Most banks have a wider range of funding sources and assets. In most cases they hold their bonds to maturity without ever realising the paper losses, analysts said.

“SVB is a special case,” analysts at Barclays wrote, but then acknowledged that “deposit pressure is greatest for smaller banks, including regionals. [Global banks] have more diverse funding sources and therefore are less vulnerable to this risk”.

Bair argued strong oversight would help reassure investors that SVB is an exception. “The Fed really needs to run the big banks through a severe stress test that includes a high interest rate scenario, something it hasn’t done since 2018. We really need to know what kind of losses they could suffer on their securities portfolios,” she said.