Silver Gate's House of Cards.

The abrupt shutdown of Silvergate Capital Corp. and the hasty fundraising efforts of SVB Financial Group has sent U.S. bank stocks plunging and the industry abuzz with rumours: Could this be the beginning of a much larger issue?

The problem at the once-thriving California lenders was an unusually fickle depositor base that withdrew funds rapidly. But beneath that is a fissure extending throughout finance: Rising interest rates have burdened banks with low-interest bonds that cannot be quickly sold without incurring losses. A vicious cycle can occur if too many customers withdraw money at the same time.

SVB's CEO urged customers on Thursday to "remain calm" amidst a surge in withdrawals of deposits.

According to analysts, the immediate threat to several banks may not be existential, but it could still be severe. In lieu of a significant run on deposits, banks will be compelled to compete harder for them by offering savers higher interest rates. That would diminish banks' earnings from lending, reducing earnings.

Small and medium-sized banks, which tend to have less diverse sources of funding, may be especially vulnerable to pressure, which could force them to sell more stock and take money away from their current investors.

Dreadful Kicking

The S&P 500 Financials Index, which tracks the financial performance of the 500 largest U.S. companies, fell 4.1% on Thursday, its worst day since mid-2020. The Santa Clara-based SVB fell 60%, while the San Francisco-based First Republic Bank fell 17%.

Another S&P index that tracks mid-sized financial companies declined 4.7%. Based in Beverly Hills, PacWest Bancorp had the worst performance, falling 25%.

In a strange twist, many stock investors bought a lot of financial stocks because they thought that when the Federal Reserve raised interest rates, lenders would be able to make more money. They have been surprised by this week.

SVB announced the stock offering as its clients, venture capital-backed companies, withdrew deposits after exhausting their funding.?

The lender liquidated nearly all of the available-for-sale securities in its portfolio and revised its annual forecast to reflect a steeper decline in net interest income.

On a conference call on Wednesday, CEO Greg Becker told clients to "stay calm." On Thursday, it was reported that a number of well-known venture capital firms, including Peter Thiel's Founders Fund, were telling portfolio companies to pull their money out of the company as a safety measure.

At Silvergate, the issue was a run on deposits that began the year prior, when cryptocurrency ventures withdrew funds to weather the collapse of the FTX digital asset exchange. After incurring losses from the quick sale of securities, the company announced on Wednesday its intention to cease operations and dissolve.

U.S. bank stocks were also under pressure this week after KeyCorp warned of mounting pressure to reward savers. Due to the "competitive pricing environment," the regional lender lowered its forecast for net interest income growth in the current fiscal year to 1% to 4%, down from 6% to 9%. Its stock fell 7% on Thursday.

Regulators openly discuss devoting less time to monitoring the balance sheets of small banks, allowing them to experiment with financial-technology platforms and cryptocurrencies.

Since the financial crisis of 2008, the government has spent most of its time and energy making sure that big banks like JPMorgan Chase & Co. and Bank of America Corp. are stable.

They have compelled the largest lenders to set aside ever-increasing amounts of capital, sometimes over the bankers' vehement objections, so that their health would be beyond reproach in times like these. Michael Barr, vice chair for supervision at the Federal Reserve, stated in a Thursday speech that smaller lenders have been handled with "a very light touch."

"Clearly, larger institutions are also exposed to these risks, but the exposure is typically a negligible portion of their balance sheets," he said. Therefore, they are more insulated, even if they experience the same deposit outflows.