The collapse of the Silicon Valley Bank has prompted fears about whether other banks might suffer a similar fate.
How can the collapse of one bank be contagious and is that likely to happen here?
Here’s what we know.
The story so far
Silicon Valley Bank (SVB) was the 16th largest in the U.S. and was popular among start-ups.
Last week, it announced some financial losses which spooked its customers. Worried about its viability, they rushed to take their money out.
Banks in that position can ‘fail’ if they don’t have enough money on hand to return to their customers (because that money is tied up in investments). That’s exactly what happened.
How contagion works
The failure of one bank can spread to other banks in two main ways.
The first is if other banks have a direct financial link to the failed bank. This is what happened in the Global Financial Crisis of 2008 – banks all over the world had the same type of questionable U.S. home loans on their books, so a failure in one threatened a failure in others.
The second way is indirect – put simply, the failure of one bank can make people nervous and cause them to scrutinise other banks more closely, triggering other panic-induced failures.
Enter: the government
So is contagion likely here?
One reason to doubt that is the swift response of the U.S. Government, which announced it would repay 100% of SVB deposits. President Joe Biden declared he would do “whatever is needed” to help banks in trouble.
This sort of intervention has its critics, who argue that it stops banks and depositors from learning their lesson. However, its explicit purpose is to calm depositors and minimise contagion.
One bad apple
Another reason contagion might be low is that SVB failed for unusual reasons.
SVB had made itself extremely vulnerable to high interest rates. Many of its startup clients had lots of investor money but not much actual revenue, putting them at risk as higher interest rates prompt investors to reassess their investments.
At the same time, SVB had taken a lot of that money and invested it in things which also perform worse when interest rates are high. This proved a dangerous combination when interest rates rose.
While these two factors may contain the contagion, there are some signs of nervousness across the world.
In the U.S, banks thought to be in similar positions to SVB (such as the First Republic Bank in San Francisco) have come under pressure in the last few days.
More broadly, bank stocks have fallen across the world, including in Australia, suggesting a general climate of anxiety about instability in the banking sector.
There is an interesting consequence of this anxiety: some analysts think it means central banks (including Australia’s Reserve Bank) will be more likely to hold off on further interest rate rises.
Essentially, this is because they’re worried that further rate rises might lead to further trouble for banks, for their depositors and for their shareholders – fuelling a wider economic fallout.