Silicon Valley Bank collapse should serve as warning to the Federal Reserve

Credible criticism

Such criticism gains more credibility when we learn that the US public debt amounts to around $32 trillion. The country also faces the dilemma of raising its debt ceiling by June in order to carry on borrowing to meet government spending commitments. 

At the same time, inflation is proving stubborn, with the consumer price index continuing to rise, even as the Fed raises base interest rates. 

Then there is the questionable impact of stress tests on banks, which were designed after the 2008 financial crisis to ensure that US financial institutions could withstand any future crises, including the threats resulting from raising interest rates via their effects on US treasury bonds, and the recession that could follow.

Caught between the hammer of rising interest rates and the anvil of their impact on its balance sheet, SVB was the first to fail the real-world version of the stress test, despite assets valued at $212 billion. 

The Federal Reserve's policy hit it hard in two major ways: 

First, rising borrowing costs have had a disproportionate effect on some parts of the US economy, including tech companies which are typically more fragile in their early stages, and which were at the core of the collapsed bank's business.

SVB's deposits of $174 billion had fallen from $200 billion at the beginning of last year, with the bank catering to about half of the US tech sector — an industry faced with changing financial conditions and that had already been struggling. It also held funds for science-based companies dealing with climate issues, which also suffered some of the most serious damage.

Second, the increase in interest rates hit the value of Treasury bonds, which banks rely on as a major part of their capital holdings. As the value of Treasuries slumped, these government bonds on banks' balance sheets were worth much less. 

Ranked in 16th place on the list of the largest US banks, SVB is the biggest to collapse since 2008. It lost 60% of its market value within hours, only one day after selling more than $20 billion's worth of assets due to a lack of liquidity.  

The move hit confidence among account holders, who rushed to pull their deposits, withdrawing $42 billion in a single day. 

An ominous sign

Since the end of last year, unrealised losses – from assets that have dropped in value but not yet been sold – reached $620 billion according to data from the Federal Deposit Insurance Corporation. 

These losses are likely to rise if the Federal Reserve continues to raise interest rates.

This is an ominous sign that an anticipated global economic crash is approaching, and it further aggravates the pessimistic outlook since Russian President Vladimir Putin's invasion of Ukraine shook up the prospects of global economy. 

Nonetheless, the clarity that follows a crash can turn it into a blessing in disguise.  

Here are some of the lessons learned so far this time around: 

First, the collapse of SVB reminds us once again that the banking and financial sector grows and prospers wherever there is trust. Once this trust is shaken, even the largest financial empires can come crashing down.

Second, in the era of social media, bank runs are faster. The panic and pressure of deposit withdrawal requests no longer takes days to build up. A few hours can be enough for the fire to spread across markets and continents. 

It only takes a single trend to test the ability of those with oversight of banking systems to avoid worst-case scenarios before they occur. This applies to central banks, regulatory and supervisory institutions, ratings and auditing companies who must pre-assess risks and identify fragilities. Governance tends to have gaps. 

Third, the response time to any banking crisis is vital and must be ultra-rapid. And it helps if comes from the highest level.

As SVB teetered on the brink, this happened in California, Washington and London, where events were managed at the highest level, from the relevant regulators right up to heads of government. 

US President Joe Biden and British Prime Minister Rishi Sunak were involved, as was the UK finance minister, Jeremy Hunt. 

They rushed to address the collapse and took the initiative to contain the repercussions. There was reassurance for banks, depositors, and tech start-ups, ahead of appropriate rescue plans. 

Inspired by the lessons of the 2008 crisis, it was immediately announced that the management of deposits in the collapsed bank would be entrusted to the Federal Deposit Insurance Corporation in the United States. 

It was clear before markets opened on Monday morning that deposits would be fully secure, over and above the maximum usually specified by the government guarantee at $250,000. Deposits were made whole without taxpayer support. 

Exceptional circumstances

The causes behind the collapse were attributed to exceptional circumstances that can be contained. Similar steps were taken to allay fears of systemic risk, covering Signature Bank as well as Silver Gate Bank, which is closely linked to the crypto industry, which is another story!

In London, authorities acted fast with a "ballistic response" to keep more than 3,000 British tech companies banking with the UK branch of SVB out of harm's way, no matter what it takes. 

Sunak followed the bailout offers to buy the UK arm of the bank while on his way to a summit in San Diego. In the end, HSBC swooped in as a white knight rescuer to buy SVB UK for £1.

There's a famous saying in Wall Street that states: "When the Federal Reserve starts raising interest rates, it continues to do so until something breaks." 

Will the collapse of SVB be seen as the time something broke this time around, leading the Fed to take a break from rate hikes? Or will the fight against inflation stoked by the outrageousness of Vladimir Putin reign for longer?