It is early days yet to assess if the collapse of Silicon Valley Bank (SVB) will turn out to be a Lehman moment for the global financial system. SVB’s failure was triggered by factors different from the ones that precipitated the Lehman collapse or for that matter, India’s bad loan crisis. If those crises were about banks piling on credit risks on their loan books, SVB’s failure can be traced to mis-management of rate risks in its investment book.
Running an asset-liability mismatch to earn a spread is central to any banking business. But SVB stretched this concept much too far in deploying its copious deposit flows into long-dated treasuries and mortgage securities, which it parked mainly in its held-to-maturity (HTM) portfolio. As inflation rose and the US Fed raised interest rates by 450-475 basis points, SVB’s portfolio racked up large losses. The advent of the funding winter, which prompted start-ups to draw down their deposits, forced SVB to liquidate not just its Available For Sale bonds but also its HTM ones. The resulting $1.8 billion write-off followed by a failed attempt to raise capital, spooked the closely-knit start-up community to launch a run on SVB’s deposits.
When interest rates shoot up in a short span, no bank can shield its investment book from losses. But SVB was more vulnerable to a run than a vanilla bank, because of its over-reliance on big deposits from a closed ecosystem — start-ups, their founders and VCs. The Federal Deposit Insurance Corporation has been quick to take over SVB, halting the run. But its ability to shore up dented depositor confidence in US banks, may depend on whether SVB’s uninsured depositors (who make up 90 per cent of its $175 billion book) will need to take haircuts. To prevent a snowballing effect on the start-up ecosystem, SVB’s clients may need to be thrown a liquidity lifeline to meet emergency payouts.
As SVB had limited inter-linkages with other banks, a contagion effect on the US or global banking system from its failure, appears unlikely. But its collapse does call for stricter regulatory vigilance on other counts. With the previous crisis stemming from lending, the current global regulatory framework for banks focusses a lot on proactive accounting of bad loans and stress-testing their impact on capital adequacy. But the SVB crisis highlights that in a scenario of rapidly rising rates, banks’ investment books need an equal degree of scrutiny and stress-testing. The present expedient of allowing banks to sweep their bond losses under the carpet by owning large HTM portfolios, can lead to blow-ups. In India, the RBI may need to scrutinise bank books for depositor concentration. The SVB saga also offers a salutary lesson to global central banks that when they switch from extended ultra-loose monetary policies to uncalibrated, sharp rate hikes to quell inflation, they can inflict damage not just on growth, but also on financial system stability that they strive so hard to protect.