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Fed moves to minimise ‘flow on’ risks amid SVB collapse

By Charbel Kadib
5 minute read

The Federal Reserve has guaranteed deposits impacted by the second largest banking collapse in US history ahead of a potential revision to its monetary policy stance. 

The US share market has taken a hit off the back of news of the collapse of Silicon Valley Bank (SVB) — a California-based regional bank primarily set up to provide capital to the now troubled technology industry.

The bank’s failure is reportedly the result of severe funding constraints, triggered by a deposit exodus and higher interest rates, and compounded by subdued tech industry investment.  

Media reports had suggested the failed bank would only guarantee up to 50 per cent of the value of customer deposits.  

However, in a joint statement, the US Treasury, Federal Reserve, and the Federal Deposit Insurance Corporation (FDIC), said they would step in to fully protect all depositors. 

“Depositors will have access to all of their money starting Monday, March 13,” the regulators noted.

A similar “systemic risk exception” would also be put in place for depositors of failed New York-based firm Signature Bank.

Bank shareholders and unsecured debt holders, however, are not expected to receive regulatory assistance. 

The regulators stressed taxpayers would not pick up the bill for losses incurred as a result of the resolutions for both SVB and Signature Bank depositors. 

Meanwhile, the Fed has committed to providing funding to eligible depository institutions in a bid to “help assure banks have the ability to meet the needs of all their depositors”.

Despite this contingency measure, the regulators assured markets that the US banking system “remains resilient and on a solid foundation”, supported by reforms introduced following the global financial crisis. 

“Those reforms combined with today’s actions demonstrate our commitment to take the necessary steps to ensure that depositors’ savings remain safe,” the regulators added. 

Market reaction

Markets were rattled by the closures of two US banks, prompting fears of contagion. 

The US stock market fell approximately 4 per cent last week in lieu of the news, while bond yields rallied.  

According to ANZ Research chief economist Tom Kenny, the circumstances surrounding SVB’s demise “appear unique”. 

“Its dealings were largely with the tech sector. Its asset and liability structure looks different to other banks and there seemed little in the way of managing the risk of its balance sheet, which mushroomed since the start of the pandemic,” he said. 

But Kenny warns “uniqueness” may not “dampen fears of a broader financial contagion”.

AMP Capital chief economist Shane Oliver told InvestorDaily the collapse of SVB is “certainly a sign of a broader issue in the economy”.

“Credit, and financial conditions have tightened dramatically and whenever that happens, it leads to problems,” he said. 

Oliver flagged the risk of a “flow on to other banks”, particularly those heavily investing in government bonds. 

“It’s another sign that financial conditions have become very tight and therefore, there’s still going to be worries that other US banks run into troubles,” he said. 

“If they have a run on their deposits — which hopefully shouldn’t happen given the government is guaranteeing all deposits — it forces selling, which then forces the sale of those bonds at a loss.” 

When asked if the bank closures would prompt the US Fed to rethink its monetary policy strategy, Oliver said the “messy” developments could soften the central bank’s stance. 

This could include reducing future interest rate hikes from 50 bps to 25 bps. 

“It probably means they’re going to have to be a bit more cautious going forward,” he said. 

As for Australia, Oliver said he expects some sentiment spillover, but noted the strength of the local banking system.

“You always see a little bit of this flow into other countries, the US is the world’s biggest economy,” he said. 

“[But] you’ve got to be careful in drawing those parallels too far because Australia has very concentrated banking system in comparison to the US.”

Australian banks are “well capitalised” and have a “much broader deposit base” than US banks. 

“So far, just like the big banks in the US, they've suffered losses on their bonds, but they’ve been able to withstand that, so I don’t think there’s a systemic threat to Australian banks at all,” he said. 

“But that doesn’t mean the share market won’t worry about it in the short term.”

Nonetheless, SVB-induced fears could strengthen expectations of a pause to the Reserve Bank of Australia’s monetary policy tightening cycle.  

“The threat of a financial crisis has traditionally gone hand in hand with easier than otherwise monetary policy, and it could be a factor which brings an end to the monetary tightening in the US,” he said. 

“Tightening cycles tend to come to an end whenever you run into a financial crisis, and I guess it just depends on how severe this one is,” he observed. 

In the meantime, short-term investors should remain cautious amid risks of a financial crisis, elevated inflation, monetary policy tightening, and continued geopolitical instability. 

“If you’re a short-term investor, and you put a lot of effort into trading, then obviously, now’s the time to be cautious,” he said.

But long-term investors should back their strategies. 

“If you’re a long-term investor, like your superannuation member, I think it’s probably best to stick to your strategy because trying to time markets is incredibly hard. 

“When people take money out in a panic, they miss out on a rebound. 

“It's inevitable, markets have their ups and downs, we’ve obviously been doing through that over the last year now and that’s continuing but trying to time that is very difficult.”