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Silicon Valley Bank: the Fed steps in to prevent contagion

When we last wrote about banks, we pointed to possible losses on trading activities and on loans to companies as potential risks that could offset the favourable impact of higher net interest margins on profits. And this is what caused some smaller US banks to fail last weekend.

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The collapse of Silicon Valley Bank has been an extreme wake-up call and has led to a change of policy to avoid a wider-ranging banking crisis. The US took timely action, steadying the market after sharp falls on the original news. It reassured depositors in many other banks that there was no need to try to withdraw their cash prematurely. HSBC is taking over the London Silicon Valley Bank and guaranteeing all deposits.

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

Silicon Valley Bank will pay out for all deposits including ones over the $250,000 limit of the standard scheme.

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 US central bank 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 disposals of assets and assessment of claims, with shareholders and bondholders – but not depositors – taking the hit.

Change in policy direction

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

Against this background a 50-basis-point rise in US interest rates at the next meeting seems unlikely. The latest economic data provided more mixed news from the labour market. There was a rise in unemployment and slowing wages set against the fast pace of jobs growth in some sectors, and wage growth remained higher than the Fed would like. This balance gives the Fed reasons to avoid unduly hawkish actions, assuming it has to continue to reassure markets about the stability of the banks.

It is all a timely reminder that a tough money squeeze designed to stem inflation can have unwanted consequences. The technology sector is already reducing its workforce and experiencing more constrained profits and cashflows. Technology companies that used Silicon Valley Bank as an industry-friendly service provider could not afford to lose their deposits, which often represented money held there to pay wages and their suppliers. These events provide a further limit on how high the Fed needs to take rates in order to slow the economy.

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Silicon Valley Bank: the Fed steps in to prevent contagion

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