Impact of Silicon Valley Bank on the Fed, Charles Stanley comments on the ongoing situation

by | Mar 13, 2023

Written by Garry White, Chief Investment Commentator at Charles Stanley

When we last wrote about banks, we did point to possible losses on trading activities and on loans to companies as offsets to the favourable impact of higher net interest margins on their profits.

We did not forecast a couple of banks failing because of these issues. Nevertheless, this happened last weekend in the US.

This has highlighted the problems in an extreme way and has led to a change of policy to avoid a wider ranging bank crisis. The US took timely action, steadying the market after sharp falls on the original news, and reassuring depositors in many other banks that there is no need to try to withdraw their cash prematurely. HSBC is taking over the London Silicon Valley Bank and guaranteeing all the deposits of that bank.

The US has taken action to guarantee all the deposits of the affected banks, to be paid for by an expanded Deposit Guarantee which on this occasion for Silicon Valley Bank will pay out for all deposits including ones over the $250,000 limit of the standard scheme. The scheme will be paid for by levy on the participating banks. This prevents contagion and makes runs on further weak banks much less likely.

The Federal Reserve (Fed) is making available a new one-year term lending facility to banks if they need additional cash and liquidity secured on their assets. The Fed will value the Treasuries, Agency debt and mortgage-backed securities it accepts as collateral at par, making it easier for banks to live through lower market prices for some high-quality assets. The Treasury has organised $25bn of backstop funds which the Fed does not think it will need. The Fed has indicated there will be other money available for regulated banks in need of liquidity so banks can meet requests for repayment of deposits. The administrators can now work their way through disposal of assets and assessment of claims, with shareholders and bondholders but not depositors taking the hit.

This represents a modest relaxation of Fed monetary policy. The main cause of the collapse seems to have been worries about Silicon Valley Bank wanting to raise additional capital because of its losses on its bond and mortgage securities portfolio. This alarmed some depositors when they heard of it and led to the attempted withdrawal of funds triggering more sales of bonds and mortgage securities at a loss. SVB is a casualty of quantitative tightening and rising interest rates.

Against this background a 50-basis-point rise in Fed rates at the next meeting of its rate-setting committee seems unlikely. In the latest economic data, there was more mixed news from the labour market. There was a rise in unemployment, a rise in the workforce and slowing wages to set against the fast pace of jobs growth in some sectors and the fact that wage growth is still a bit higher than the Fed would like. This balance gives the Fed reasons to avoid unduly hawkish actions assuming it remains concerned to reassure about the banks.

It is all a timely reminder that a tough money squeeze can do more damage than just slow things down. The technology sector is already reducing its workforce and experiencing more constrained profits and cashflows from the reduction of growth. Technology companies that used Silicon Valley Bank as an industry friendly service provider could not afford to lose their deposits which was often money held there to pay the wages and their suppliers.

The action to protect the deposits was necessary to prevent bankruptcies by companies that had money but could not access it, and to stop that spilling over into losses for their suppliers. These events provide a further limit to how high the Fed needs to take rates to slow the economy.

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