Silicon Valley Bank was shut down by regulators on Friday, March 10. This is the second largest bank failure by size (unadjusted for inflation) in U.S. history. This is a standard regulatory practice when a bank begins to either have liquidity or solvency issues.
Who is Silicon Valley Bank?
Silicon Valley Bank is a unique bank that provides a high level of loans to corporate (tech) and venture capital companies while generally encouraging those companies to keep their corporate cash accounts at the bank. The vast majority of the companies’ deposits were above the $250,000 FDIC limit, and not technically insured. Ultimately, the FDIC announced full protection for depositors – even those deposits above the $250,000 FDIC limits.
Were Other Banks Impacted?
Signature Bank was closed by regulators on Sunday. Ultimately, the FDIC announced the same full protection for depositors – even those deposits above the $250,000 FDIC limits. Smaller regional banks stocks are as expected down today.
How Does a Bank Fail?
A bank works on a fractional reserve system, which means it can lend out more than the deposits it takes in (leverage) and makes a spread (net interest margin) between the yield it pays to attract deposits and the interest it charges for loans. The bank also has a securities portfolio where it invests in bonds, usually Treasury securities. It must maintain certain capital ratios (loan to deposit ratio and capital adequacy requirements). The first risk of failure is credit risk, basically the loans it makes goes bad. The second risk is duration risk, where depositors demand their money now while the money is lent out or invested in securities that have not matured yet.
Is This Another 2008 Global Financial Crisis?
We do not see it like that. While the banking system is stressed by a major bank failure, the banking system in general is over-capitalized. The major banks considered global systemically important institutions (GSIBs) today abide by the Total Loss Absorbing Capacity Rules (TLAC) that was put in place after the 2008 crisis. Silicon Valley Bank, Signature Bank, and regional banks have not been subject to those rules. In brief, what that means is that GSIBs had to reflect securities held in the bank’s securities portfolio reflected in regulatory capital ratios, while those not considered GSIBs did not have to. We see that changing quickly and a new requirement to require all banks abide by the same or similar criteria.
Is My Investment Account Safe?
It’s important to make a distinction between an account at a bank and an investment account. When a customer deposits money at the bank, it becomes a liability of the bank (i.e. put on the bank’s balance sheet to loan). This is why there is FDIC insurance for depositors to protect the depositor from the bank’s balance sheet risk. On the other hand, an investment account held by the major custodians (TD, Schwab, Fidelity, etc.) are held in a segregated account for you and do not become part of the firm’s balance sheet. This might be a good time to review any bank accounts that might be over the FDIC limit and consider diversifying banks or placing it in an investment account to alleviate certain bank specific risks.
What is The Expected Market Impact?
In the short term, we expect equities to move quickly based on the latest headlines in an evolving situation. However, the bond market has moved decisively and is the important indicator we are watching. The 2-Year Treasury went from a yield of 5% to about 4% (bond prices rise when yields decline) in less than 5 days. This is an enormous move in the bond market and is telling us the bond market expects the Fed to ease up if not stop any further interest rate increases. After the dust settles, that should alleviate the pressure that rate increases have put on stocks and bonds.
What Should Investors Do?
We believe investors are best served by allocating long-term investment assets to a globally diversified portfolio consistent with their risk profile and maintaining a solid discipline to allow the markets to work over-time. The chart below is a good reminder why we think it’s time, not timing, that is the key to achieving long-term success in the market.