Silicon Valley is the birthplace of new technologies. But it was an old-fashioned bank run that led to the collapse of one of its best known lenders.
On Friday 10th March Silicon Valley Bank (SVB) was shut down by US regulators, marking the second largest bank failure in US history after the closure of Washington Mutual in 2008. Over the weekend, Signature Bank in New York also closed. The news unsettled equity investors, with the global financials sector falling by more the 6.5%1 over the past week.
The intervention of the Federal Reserve and the Federal Deposit Insurance Corporation (FDIC), as well as the sale of SVB’s UK branch to HSBC, have protected deposit holders and mitigated broader disruption. However, the question remains whether SVB is symptomatic of broader issues in the banking system or whether its issues were more idiosyncratic.
SVB was not a typical bank and was distinguished from its peers by two key characteristics. The business model was focused on the venture capital ecosystem, with a particularly high concentration of customers in the tech start-up space. The boom in speculative investment in small technology firms in recent years resulted in more than 200% growth in both the banks’ assets and deposits.
As a result, by the end of 2022 SVB had a poorly diversified customer base that was increasingly concentrated in large corporate accounts, with just 12% of its deposit base below the FDIC’s limit of $250,000. Typically, US banks have a far more diversified deposit base with a higher proportion of smaller accounts and are therefore far less exposed to the risk of large deposit outflows.
The second key difference is the way in which SVB managed its balance sheet. Rather than matching deposits with loans, SVB instead largely invested in long-dated and fixed-rate government bonds. As interest rates have risen over the past year, the value of these assets declined at the same time as inflows into tech start-ups (and therefore deposit growth) slowed. This dynamic squeezed profitability and weakened the balance sheet.
Again, this is not representative of the average bank. Whereas securities constituted 56% of SVB’s assets, the corresponding figure at Bank of America is 28%. This is still a significant exposure to bonds with implications for profitability, but more balanced banks are far better placed to navigate the challenges posed by rising interest rates after a prolonged period of exceptionally low rates. The read across from SVB to US or global banks more broadly seems relatively limited.
The Federal Reserve has provided short-term support for small US banks through a series of emergency funding measures. This should limit the potential systemic risk. The question remains, however, whether there will be any implications for the future direction of US monetary policy.
Investors have spent months betting that the Federal Reserve is nearing the end of their rate hiking cycle as inflationary pressures have started to ease. Our view has remained that this was unlikely as long as economic and labour market data remained robust. However, if SVB’s demise and the potential for other small US banks to follow suit is seen to constitute a threat to financial stability, then the Fed may look to revise the current policy course. The volatility we have seen in interest rate expectations suggests that investors are starting to price in this potential scenario.
Within our core models, none of our active equity funds had exposure to SVB. Our only exposure to SVB’s shares came through its 0.05% weighting in an S&P500 ETF. More broadly, we are neutral US financials in comparison to our equity benchmark, with our exposure focused on larger, higher quality companies.
None of our active fixed income funds held SVB bonds. Again, our only exposure came through a broader market ETF – in this case, a global corporate bond ETF with an 0.03% weighting to SVB.
We did not have any exposure through our money market funds.
From a corporate perspective, SVB was not an authorised counterparty for Cazenove Capital or Schroders Wealth Management.
1 Performance of MSCI ACWI financials index, total return, GBP-denominated
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