A resilient U.S. banking system weathers the SVB crisis

In the wake of Silicon Valley Bank (SVB) falling into receivership, markets have understandably been attempting to identify other institutions or segments of the broader economy that may be at similar risk. Importantly, we view the U.S. banking system as well capitalized. What occurred at SVB, in our view, was the result of the combination of its unique depositor base and the portfolio of longer-dated securities held on its balance sheet.

Even a healthy banking system such as that of the U.S. is at risk of a bank run, a situation in which depositors seek to withdraw funds – for reasons founded or unfounded – that can far exceed a bank’s cash on hand. This is perhaps the most fundamental reason why banks are heavily regulated; governments are not keen on seeing a country’s citizens lose their savings. The U.S. banking system is designed to have the mechanisms and processes in place to mitigate this risk and, in the event of a bank run, resolve it in the least disruptive manner possible. These mechanisms were fortified in the wake of the Global Financial Crisis (GFC).

What occurred with SVB was primarily due to interest rate risk, given last year’s historic rise in policy rates. While our team of analysts are thoroughly analyzing all segments of the banking and broader financial sector to identify other potential sources of stress brought on by higher rates, we believe that the U.S. banking system is resilient and that most institutions can weather this bout of idiosyncratic volatility.

A convergence of forces

In response to the global pandemic, authorities unleashed a wave of liquidity. Much of it was channeled into risk capital seeking a home. A favored destination was early-stage technology or biotech companies. Such funds turbocharged SVB’s deposit base. The tech sector’s recent slowdown, however, not only dried up venture-backed companies’ sources of funding, but also forced them to draw down their accounts to meet payroll and other expenses. These withdrawals accelerated early this year; in response, SVB management announced it would sell certain securities and raise additional capital. In a different environment these moves likely would have been sufficient to fortify SVB’s finances. However, given the concentrated nature of SVB’s deposit base, the initial concerns over its balance sheet snowballed, resulting in last week’s run on deposits.

The business of banks

Banks are in the business of maturity transformation: taking deposits (liabilities) that implicitly can be withdrawn on demand and using them to fund loans and other assets with a considerably longer duration. Banks can easily handle a limited amount of net withdrawals over shorter periods – levels far below the reported roughly 25% demanded by SVB customers in a single day.

Recognizing this mismatch, regulators have designed systems to assuage the concerns of depositors. Among these mechanisms are deposit insurance, and liquidity access via the Federal Reserve’s (Fed) discount window and the Federal Home Loan Bank. Another is a capital buffer in the form of equity. The size of this capital cushion was increased post GFC, especially for systemically important institutions.

Anticipating the ramifications

We don’t believe the unique forces that led to SVB’s receivership present a systemic risk to the U.S. banking system. But the increase in interest rates has heightened the market’s sensitivity to other situations that may unfold in a similar fashion or the potential repercussions that may flow from this episode. And as evidenced by the behavior of SVB’s concentrated client base, a single catalyst can result in these depositors reacting in a very similar way.

As evidenced by the market’s reaction, we are monitoring developments in regional banks, especially those with a concentrated base of commercial depositors. We are also seeking to identify banks that have allowed the duration of their held securities to materially increase.

We believe regulators’ weekend moves of insuring SVB’s deposits with immediate effect and the implementation of a facility where banks can borrow against their held securities at par value should go a significant way in re-instilling investor confidence in regional banks. Yet risks remain.

Given the role that SVB has played in servicing the U.S.’s thriving tech sector, any impediment to these companies’ ability to access financial services could become a headwind to future innovation and growth. We would also expect to see the regulatory oversight of regional banks rise. This would have the inevitable effect of increasing these mid-sized institutions’ compliance costs, and thus must be factored into their earnings expectations. Lastly – and as evidenced by the bond market’s reaction – these still-unfolding events may impact the Fed’s previously well-telegraphed plans for rate hikes over the remainder of 2023.