On March 10, the Silicon Valley Bank (SVB), the 16th largest bank in the United States, failed, leading to widespread concern over the regional banking industry. The proximate cause of the failure was $42 billion in deposit outflows in a single day, triggered by depositor concerns over a reported $1.8 billion realized loss on the sale of long-dated bonds.
How did this happen? Like many banks in the United States, government stimulus spending led to a massive influx of deposits at SVB, nearly doubling to $198 billion by the end of the first quarter of 2022. As demand for commercial loans remained relatively tepid through 2021, the bank poured a large portion of these excess deposits into long-dated government-related bonds.
By mid-2022, it was clear that inflation was more than a transient problem, and the Fed began significantly increasing interest rates. This posed a dual challenge for SVB. On the one hand, higher rates made relatively low-yield deposit accounts less attractive to the bank’s customers. On the other hand, the higher rates led to declining market values for the bank’s bonds. Unlike most banks, SVB left the interest-rate exposure in their bond portfolio largely unhedged.
This came to a head in early March 2023, when the bank was forced to sell $21 billion worth of underwater bonds, locking in a realized loss of $1.8 billion. This loss was revealed to the market after-hours on March 8 and triggered the massive deposit outflows the following day. Those outflows left the bank with a negative cash balance of $1 billion, leading the FDIC to force the bank into receivership.
The root cause of these events was a deficient risk culture at the bank. This will have implications for risk management in the banking sector globally, including how regulators evaluate risk governance in their oversight and supervision, both implicitly and explicitly. The banks that understand this quickly and get ahead of the issues will be at an advantage relative to their peers.
