SVB: the wash-up of a bank collapse

With the recent collapse of the Silicon Valley Bank (SVB), which marked the second largest bank failure in US history, concerns have been raised about the stability of the entire financial sector.

Could a major bank collapse happen here in Australia? And what would this mean for our deposits?

What is Silicon Valley Bank?

Established in 1983, SVB made its name as the go-to bank for tech companies. While relatively unknown outside of Silicon Valley, SVB was the 16th largest bank in the United States, with US$209 billion (AUD$317 billion) in total assets at the end of last year.

Why did it collapse?

Throughout the COVID-19 pandemic, SVB witnessed a significant increase in deposits as tech companies profited from providing entertainment and digital services to people confined to their homes.

SVB invested much of these deposits in US government bonds, which were widely regarded as one of the safest investment options.

However, SVB’s downfall began when the US Federal Reserve began to raise interest rates last year in response to skyrocketing inflation.

SVB’s tech clients were adversely impacted by the high interest rates, which led to a substantial reduction in their valuations and severely restricted their ability to raise additional funds. At the same time, the increased interest rates also caused the value of the government bonds held by SVB to plummet (when interest rates rise, bond prices fall).

If SVB had been able to hold the government bonds until maturity, it would have received the principal investment back in full. However, as SVB’s clients faced an increasing cash crunch, they began to withdraw their funds to sustain their operational needs. As a result, SVB was forced to sell the bonds at a loss to meet clients’ withdrawal demands.

When SVB publicly acknowledged that it had sold the bonds at a loss, it triggered panic among customers who withdrew more significant amounts of cash. This resulted in a bank run, and SVB was unable to fulfil the withdrawal demands by selling more bonds at a loss, ultimately leading to its collapse.

Have bank customers lost their money?

Fortunately for SVB customers, the US federal government has stepped in to guarantee their deposits, including the $151.6 billion in uninsured deposits. This decision was made to prevent the SVB’s collapse sparking a domino effect and causing additional bank runs at other banks. It also aims to assist companies to continue paying their employees and fund their operations.

The costs of this will be borne by the banks that fund the deposit insurance system. However, SVB’s shareholders and bondholders who loaned money to the bank will not be covered and therefore face the possibility of losing their entire investments.

Could a major bank collapse in Australia?

Industry experts believe that a major bank collapse, similar to SVB, is highly unlikely to happen in Australia (see this article in the AFR for recent commentary).

As mentioned, SVB’s customers were concentrated in one sector, which created a liquidity risk. In contrast, most major banks in Australia have a more diversified customer base.

Many Australian banks focus on mortgages as their primary type of lending and the majority of these have floating rates of interest. Accordingly, most of their assets move with interest rates, providing further protection for the stability of Australian banks.

 Finally, the structure of the balance sheets of Australian banks and the regulatory incentives developed by the Australian Prudential Regulation Authority (APRA) to promote the matching of assets and liabilities, make an SVB collapse less likely to occur in Australia.

What would happen if a bank collapse did happen in Australia?

In 2008, the Australian government introduced the Financial Claims Scheme (FCS) following the Global Financial Crisis (GFC). Under the FCS, the government provides protection and prompt access to your deposits in any authorised deposit-taking institutions (ADIs) – which includes banks, building societies and credit unions – in the event that one of these financial institutions goes under. 

It is important to note that there are limits to the FCS guarantee. The government will only guarantee up to $250,000 per account holder. This means that if you have more than that amount deposited with one ADI, you will not be guaranteed anything beyond $250,000. However, if you have deposits spread across multiple institutions that collectively amount to more than $250,000, you’ll receive up to $250,000 back for each account – that’s why it may be beneficial for you to consider having accounts with more than one bank.

Additionally, this $250,000 limit applies to a banking licence. This is important as multiple banks may operate under a single banking licence. Therefore, all of the deposits you hold under one banking licence – even if they are spread across different institutions – must be added together towards the $250,000 limit. For example, let’s say you have two bank accounts: an account with Bank A which has a balance of $200,000; and an account with Bank B which also has a balance of $200,000. Assume that Bank A owns Bank B and so both operate under Bank A’s banking licence. In this scenario, if Bank A fails, only $250,000 of your $400,000 total can be recovered under the FCS, as both banks operate under the one licence.