Wealth in Practice - March Edition

Wealth in Practice – What does the collapse of Silicon Valley Bank mean for your clients?

Moneycube's Wealth in Practice newsletter provides insights, resources and tips for professional advisors in Ireland. From the financial experts at Moneycube, it features opinions, technical updates, and a focus on wealth and pensions to help you advise your clients.

This month: The collapse of Silicon Valley Bank

For most professionals in Ireland, memories of bank collapses are still raw.??So it’s no surprise the Irish government and others are paying special attention to news of the collapse of US-headquartered technology lender, Silicon Valley Bank.??

For now, the risks to Irish tech companies who used SVB for banking operations look low, after FDIC in the US and HSBC in the UK have assumed its obligations.??Read on for a briefing on what happened, and five likely implications for you and your clients.

"Perhaps what happened in the next 48 hours is the most interesting bit. Policymakers in charge today earned their stripes in the financial crisis of fifteen years ago, and know the value of acting at speed to limit contagion in the wider banking sector"?

What happened?

Silicon Valley Bank, a $200 billion bank and member of the S&P 500 index of top US stocks, has been the subject of an old-fashioned bank run.??In some ways, the bank was a victim of its own success.??It grew fast through the pandemic tech boom, and sought to invest its cash deposits in long-dated US Treasury bonds.?

But although there are current opportunities in short-dated bonds (see last month’s issue), long bonds have lost much of their tradeable value over the last year as interest rates have risen.??If held for the long term, these bonds would retain their headline value.??Selling them today would require taking a loss.??That led to SVB’s announcement last Wednesday that it planned to raise $1.75 billion.??That prompted customers, many of whom. In 48 hours, the bank collapsed, the largest bank failure since Washington Mutual in 2008.?

What happened next?

Perhaps what happened in the next 48 hours is the most interesting bit.??Policymakers in charge today earned their stripes in the financial crisis of fifteen years ago, and know the value of acting at speed to limit contagion in the wider banking sector.??Before European markets opened on Monday, the UK’s largest bank had stepped in to purchase SVB’s UK bank.??And in the US, they acted to protect all depositors using deposit insurance funds paid by US banks – both for SVB and Signature Bank, a New York bank caught up in the crossfire.?

Five implications of the Silicon Valley Bank collapse

What’s remarkable is the speed of SVB’s crisis – and the policy response.??The bank was dependent on fewer, larger customer, which meant the outflow of funds was very rapid. It’s early days, but here are five likely implications of Silicon Valley Bank’s demise.?

And the problem isn’t confined to the US. AIB and Bank of Ireland shares have slipped around 13-14% over the last week.?

1.??????Fears of contagion in the banking sector

The first worry was a fear that contagion could spread in the banking sector.??We know what that feels like from last time.??And sure enough, bank stocks were among the worst hit, with the S&P 500 banks index slipping more than 15% before a modest recovery yesterday.??And the problem isn’t confined to the US. AIB and Bank of Ireland shares have slipped around 13-14% over the last week.?

But the effect on the banking sector is likely to be quite confined.??Other banks will suffer the same problem of losing value in their bond holdings.??But the basic error of matching too great a proportion of customer deposits (repayable on demand) with long bonds (whose value is guaranteed only over the long term) will be less widespread – not least due to regulatory stress tests.?

All European banks – and larger US ones – are subject to stricter liquidity regulations and stress tests than those applied to SVB.??That gives a key element of additional protection against the risk of a rush on customer deposits.

2.??????Implications for interest rates

SVB’s collapse will have a greater impact on lending and interest rates.??The failure of SVB highlights some of the unintended consequences of rising interest rates.??The US Federal Reserve meets next week to review interest rates.??The market has moved from an expectation of a 0.25%-0.5% rise, to the 0%-0.25% zone.??One bank even predicted a cut to interest rates.

"Expect more caution and less supply when it comes to lending, especially into the tech sector".

3.?????Impact on lending and the tech sector

While lower interest rates might seem good news for borrowers, there will surely also be an impact on lending into the tech sector.??A key funder to startups and VC-backed companies has left the market, and other lenders will have been spooked by how quickly a bank dependent on a single sector can fail.??

Bank shareholders and depositors are nervous.??Expect more caution and less supply when it comes to lending, especially into tech sector.

At the same time, this crisis raises some interesting questions about the real beneficiary of a bailout here – the VC-backed tech sector which had major exposure to a risky bank.??VC-tech is supposed to be at the heart of capitalise endeavour.??Now it’s the main beneficiary of government-brokered rescue deals. Is the tech sector too big to fail?

4.?????Flight to quality

It’s noticeable that the failure of two relatively small banks has seen the big players ride to the rescue.??Europe’s largest bank rescued the UK division, while the largest US banks will play a key role in protecting the US HQ.??SVB and Signature were deemed small enough to fail.??But others are not.??It’s likely some depositors will choose to place the bulk of their funds in institutions which fall into the second category, and smaller banks will have to work harder if they want deposit funds.

5.?????Impact on markets

Finally, there’s the impact on global markets.?

The shock has (ironically) prompted a rise in bond values as investors adjust to a likely change in interest rates.??

Bond yields move in line with interest rate expectations.??And when bond yields fall, bond prices rise: and the yield on two-year US Treasury bonds chalked up its largest fall since 1987 on Monday.

At the same time, stock markets pulled back sharply late last week, before staging a partial recovery over the last 48 hours.

We’ve been seeing heightened volatility in markets for some time now, and SVB’s collapse will only continue that trend.

But over the medium term, it has scope to stabilise the rises in interest rates, which is likely to favour those invested in risk assets.??

Conclusions: The risks of fighting the last war

They say that soldiers are trained to fight the last war.??Investors need to be alive to the same risk.??The effects of this bank failure won’t be what we saw in the banking crisis.??So perhaps we should worry less about bank contagion and liquidity crises.??Those risks are closely monitored for the world’s big banks.?

The root cause of SVB’s failure was an unintended consequence of a world of rising interest rates.??There have been others – for example, the crypto crisis, and the UK liability-driven investment pension crisis in autumn 2023.

It’s time to consider what other unintended consequences might be lurking out there.?

That might include, for example:

• the fact that efforts to control inflation will likely weaken;
• the emergence of a two-tier banking system where big banks get even bigger;
• whether the tech sector is now seen as too big to fail.

We would be happy to meet with you to discuss ways in which we can support you and your clients with their wealth and employee benefits. Drop us a line at [email protected]