KOREA CAPITAL MARKET INSTITUTE

The parent company of Silicon Valley Bank (SVB), the 16th largest bank in the US in asset value, filed for bankruptcy on March 10, 2023. SVB was the largest commercial bank in Silicon Valley, California, the area known for being home to various high-tech industries. As it has achieved growth by attracting tech startups and promising venture capitalists in Silicon Valley, the aftereffect of its collapse is expected to persist for a considerable period of time. Given that SVB has so far provided banking services to almost half of venture capital firms and startups operating in the US, they are likely to face difficulties securing loan financing for some time. In addition, there will be persistent concerns about the failure of other banks suffering from financial vulnerabilities. This seems to exert influence on the US Fed’s monetary policy and bank supervisory policy, deepening public anxiety over the slowdown in the US economy.
       
It is worth understanding what the fall of SVB means as it is expected to send shock waves through Korea’s economy and financial market via various channels. Korean markets have been already hit hard by the funding crunch triggered by the Legoland crisis that occurred in October last year. If external shocks are added, it could call into question the soundness of Korea’s vulnerable financial services firms. This year, Korea seems to struggle with a sharp decline in the economic growth rate and trade deficits. Under the circumstances, the downfall of SVB is anticipated to accelerate the global downturn while placing indirect pressure on Korea’s corporate performance and export sector. Against this backdrop, this article takes a look at the underlying cause and features of SVB’s insolvency and examines the potential effects of the US bank failure on the Korean financial market. It also intends to present what policy implications it offers for risk management in the financial market.


What went wrong at SVB and what made its failure unique

Founded in October 1983 in San Jose, California, SVB has been based in Santa Clara, California until it was shut down. From its inception, SVB adopted an unusual strategy targeting startups as its main customer base. Although the US is widely accepted as the most advanced economy in the world in terms of venture finance, American banks rarely recognized the importance of financial services for startups in the 1980s. Nevertheless, SVB’s bold attempt to carry out the strategy has resulted in great success. Thus, the demise of SVB indicates that even a pioneering bank could fall into bankruptcy if it fails to stick to basic rules for risk management in the face of surging interest rates.
 
The bankruptcy filing of SVB just happened so fast. SVB had $62 billion in total deposits in March 2020, which ballooned to $124 billion in March 2021 and rose again to $175.4 billion as of end-2022. In the aftermath of the Covid-19 pandemic, an explosion of investment demand for bio and high-tech companies led startups in Silicon Valley to accumulate assets, which created a massive capital inflow into SVB. With the abundance of deposits, the bank made a strategic decision to invest the excess surplus in long-term US Treasury bonds. This decision hardly seemed to invite criticism, given the zero interest rate policy and liquidity provision policy implemented by the Fed between 2020 and 2021. But inflation rose sharply starting from 2022, and especially Russia’s invasion of Ukraine that took place in March 2022 sent inflation to reach its highest level since the 1980s, thereby encouraging the US Fed to initiate the cycle of base rate hikes. As the Fed launched its attack against inflation, it dealt a lethal blow to SVB’s balance sheets. Bond yields usually move opposite to interest rates. In particular, longer-term bonds suffer a bigger decline in times of rate hikes. As the largest portion of SVB’s assets was invested in long-term US Treasury bonds, rising interest rates led to the exponential growth of losses on valuation of bonds, which exceeded $15 billion as of end-2022. As the Fed’s rate hike cycle continued well into 2023, concerns were growing over the financial health of SVB and depositor withdrawals commenced in full force in March this year. To handle surging withdrawals, SVB had to sell off its bond holdings, which turned its unrealized valuation losses into realized losses. As a way of tackling the liquidity crisis, SVB disposed of securities worth $21 billion to secure cash on March 8 and raised fresh capital of $15 billion through borrowings. SVB unveiled that the sale of its bond holdings incurred $1.8 billion in final losses. Global credit rating agency Moody’s concluded that despite such efforts, SVB’s liquidity risk kept mounting and downgraded its credit rating from A2 to Baa1.¹⁾ As a result, SVB saw its stock price plunge on March 9, paving the way for a bank run on deposits. A total of $42 billion was withdrawn from deposits on the same day alone. SVB’s stock lost 66% of its value on March 10, thereby calling a halt to its stock trading. The California government canceled SVB’s banking license on the same night and named the Federal Deposit Insurance Corporation (FDIC) as the receiver. This is how the largest commercial bank with 40 years of history in Silicon Valley was forced out of the market as quickly as a flash of lightning.
     
SVB’s collapse represents not only characteristics typical of financial institutions’ bankruptcy process but also new specific features arising from recent changes in the financial environment. By underlying cause, the characteristics of SVB’s failure can be summarized as follows. First, the noticeable maturity mismatch between asset holdings and deposit liabilities and the concentration of investment assets are primary factors behind the insolvency of SVB. The bank used an excessive amount of customer deposits to buy long-term US Treasury bonds. From the profit maximization perspective, SVB’s asset holding strategy can be justifiable to some extent. As the prevailing forecast was that the Fed would continue its zero interest rate policy in the wake of the Covid-19 pandemic, long-term bonds, rather than short-term bonds hardly generating interest income, should be a preferred choice. Furthermore, US treasuries are bonds issued by the government and thus, their credit risk seems to be fully controlled. However, investing funds from deposit liabilities with a short maturity in long-term instruments is bound by a liquidity crisis, no matter how small the credit risk may be. The maturity mismatch has been found time and again to contribute to bankruptcy cases of financial institutions, especially banks. Another primary cause is the concentration of assets under management (AUM). The loan portfolio of SVB was regarded as pretty stable but most of its AUM was put into long-term US Treasury bonds.²⁾ The investment industry underscores that too much reliance on a specific asset class must be avoided. “Do not put all eggs in one basket” is a fundamental canon of investment, which also applies to banks’ asset management. The failure to adhere to the diversified investment principle has cost SVB a great deal.
 
Second, the collapse of SVB was partly driven by the Fed’s failure to oversee the banking sector. In the wake of the 2008 global financial crisis, the US reinforced the financial soundness management system for banks by introducing the Dodd-Frank Act. With the adoption of the Economic Growth, Regulatory Relief, and Consumer Protection Act (EGRRCPA) in 2018, the threshold of financial health-related regulations was raised from banks with $50 billion or more in assets to banks with less than $250 billion in assets. SVB was one of the banks that benefited from the threshold adjustment. Under the EGRRCPA, SVB became eligible for a more relaxed stress testing requirement compared to other large banks, and the Fed also took a more predictable and flexible approach to oversight of banks with less than $250 billion in assets. Eased requirements seemed to help improve SVB’s balance sheets by bringing about changes to its asset composition. But an unexpected surge in rates brought to light structural vulnerabilities in SVB’s financial soundness management system, leading to the tragic consequence of bankruptcy.
          
Third, it is noteworthy that the common use of banking services via mobile phone and social media has helped immensely speed up the failure of SVB, albeit not a direct contributing factor. As smartphones have made mobile banking services commonplace, deposit transfers from banks are no longer constrained by time and place. This has opened up a new era in banking when all deposits would be withdrawn from a bank in less than a day and a bank run for half a day is enough to make a bank collapse. During the March 9 bank run, deposit withdrawals from SVB amounted to a whopping $42 billion in just one day. It is hard to deny that information and opinion sharing via social media and the resultant deposit withdrawals through mobile banking services have served as a catalyst for the rapid-paced bank run. These changes in the financial market landscape are expected to pose a major challenge to central banks and governments in terms banks' financial soundness management. In a world where a bank run can leave a bank completely insolvent in three to four hours, governments would not have much time left to come up with appropriate policy means for preventing a bank failure. The widespread use of social media and banking services via mobile device has become an irreversible trend. Technological breakthroughs have enhanced convenience in how financial services are provided. But it should also be noted that these changes in the financial environment can maximize the flammability of bank runs.

             
How SVB’s failure affects financial markets at home and abroad

There are conflicting views over what impact SVB’s closure will have on the economy and financial markets in the US and globally. But one thing for sure is that the struggles for SVB are unlikely to escalate into systemic risk across the entire financial market, which is in contrast to how the collapse of Lehman Brothers accelerated the global financial crisis in September 2008. The current outlook for the global economy is not bright, considering a series of bank failures and insolvency risks that occurred in March 2023. On March 8, the cryptocurrency-focused bank Silvergate Bank announced voluntary liquidation due to cumulative losses on securities. Following the crash of SVB on March 10, the crypto-friendly bank Signature Bank headquartered in New York failed on March 12. Credit Suisse (CS), Switzerland’s global investment bank with $575 billion in total assets, took emergency liquidity assistance of about 50 billion francs from the Swiss National Bank in an attempt to avoid insolvency and Switzerland’s another bank, UBS agreed to buy its beleaguered rival. CS has long been rumored to be at risk of insolvency due to its mounting losses for years. UBS’ takeover of CS will make the bank out of the woods but it may take considerable time to turn itself around. Despite such negative developments, a string of bank failures including SVB’s downfall are less likely to have a spillover effect on financial systems, which is quite different from the 2008 global financial crisis.
     
The collapse of US banks is unlikely to develop into systemic risk and spread a financial crisis across the entire system, mainly thanks to the efforts of the US government and Fed. They fell short of avoiding the collapse of banks but have taken prompt action to prevent bank failures from spreading to the banking system. As soon as SVB filed for bankruptcy, the US government announced that it would temporarily lift the $250,000 per account deposit insurance cap to fully cover total deposits. The Fed introduced a special lending program for banks to prevent those struggling with a liquidity crisis from going bankrupt. Under the Fed’s Bank Term Funding Program (BTFP), loans of up to one year are offered to banks pledging US treasuries, mortgage-backed securities (MBS) and other qualifying assets as collateral. These assets will be valued at par. The BTFP will be a valuable source of liquidity for a bank suffering from liquidity constraints due to losses on valuation of their holdings. The full deposit insurance and special liquidity provision program for banks are expected to significantly help curb additional bank runs by alleviating the fears of depositors and investors.
    
Also, it is worth considering that the latest bank failures can be characterized by a liquidity crisis that arose from losses on valuation of assets amid interest rate hikes, not by an accumulated credit risk posed by distressed assets. Despite huge losses on valuation of asset holdings, SVB would not have collapsed with abundant liquidity. But it seemed almost unthinkable that programs like the BTFP would be put in place because the Fed kept up intense monetary tightening. Still, if a bank failure arises from factors other than insolvency, it would be relatively easier to take the situation under control. It would also take less time and effort to come up with countermeasures and restore the confidence of depositors and investors.
   
For these reasons, there is a limited possibility that a series of US bank failures that occurred in March 2023 lead to a repetition of the 2008 global financial crisis. Although market unrest, such as a stronger preference for safe assets and higher price volatility, could last for some time in the US and global financial markets, concerns about a financial crisis are unlikely to plunge the market into a panic. A reduced supply of funds for startups may worsen the risk of economic slowdown in the US. However, the lack of funds is expected to have lingering effects, rather than kicking in immediately.
   
The potential impact of SVB’s collapse on Korea’s financial market seems to be not much different from its impact on global financial markets unless the economic conditions of the US and Europe are worsening out of control. On the internal front, the financial health of Korea’s major commercial banks is good enough to meet global standards. Despite concerns about the default risk of household debts and real estate PF, Korean banks that achieved the best-ever performance in 2022 would be capable of absorbing risks from the current bank failures. The Korean government also seems to bring risks from the financial market under control by taking aggressive market stability measures. Although market indices including stock prices, market interest rates and exchange rates are inevitably subject to price falls and higher volatility, such conditions would rarely send the entire market into a panic.

 
Implications of SVB’s failure and countermeasures
 
The failure of SVB is another prime example of how important risk management of financial services firms and the relevant regulatory framework are to their sustainability. Although the primary goal of financial services firms is to seek profits, it is also necessary to reconcile the balance between profits and soundness, depending on changes in the environment. During the period of mounting risks which started last year and has continued well into 2023, firms need to focus on managing financial health. As Korea’s major commercial banks have fulfilled requirements for liquidity and capital adequacy, they hardly face great difficulty enduring external shocks. However, further measures should be taken to strengthen banks’ risk covering capacity, considering the risk of household and corporate debt deterioration, concerns over the default of real estate PF fueled by the slump in the property market and the possibility of additional shocks from abroad. What is also urgently needed are banks’ voluntary efforts to enhance a safety valve and the government’s policy support. In the face of SVB’s demise, some are raising concerns about the usefulness of specialized banks. But it should be noted that the collapse of SVB was not the result of the limitations of the specialized banking model. Thus, it should not impose a burden on current financial policy aiming at alleviating banks’ oligopoly and promoting competition. Reinforcing banks’ soundness management and enhancing competition hardly seems to be a mutually exclusive policy mix, and it is reasonable to assume that side effects of increased competition in Korea’s banking industry would not lead to the deterioration of banks’ financial health.
           
In the wake of the fall of SVB, there are rising expectations that the Fed will stop hiking interest rates soon and begin to cut rates as early as this year. But the impatient assumption for a potential interest rate cut is something that we need to be wary of. The Fed implemented the BTFP to provide liquidity after SVB went bankrupt, which, however, hardly means any shift in its monetary policy direction. The BTFP is a policy measure that can be defined as a symptomatic treatment to mitigate the side effects of monetary tightening. The Fed has learned from its tighter course of monetary policy in the late 1970s that inflation control is not easily attainable and comes at a considerable cost. Hence, it is likely to perceive SVB’s failure as a cost factor, rather than a contributor to a change in monetary policy.
 
The possibility that SVB’s crash escalates into a major crisis in a short period of time is limited but there remains a risk that another funding crunch poses a challenge to the global financial market going forward. Accordingly, it is necessary to step up liquidity and soundness management measures for financial services firms including banks and to establish financial market stabilization facilities in preparation for an emergency. As demonstrated by the collapse of SVB, financial services firms are highly likely to go into bankruptcy at an unprecedented pace down the road and governments may have little time left to put into action any policy response. Hence, there is a growing need for manualizing policy responses in advance and swiftly creating and executing an appropriate policy mix, depending on the intensity of shocks.
 

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1) A2 and Baa1 ratings given by Moody’s are equivalent to S&P’s A0 and BBB+. 
2) US Treasury bonds account for a whopping 55% of SVB’s total assets and long-term bonds out of SVB’s US Treasury holdings represent as high as 80%.