Silicon Valley Bank collapse puts Fed’s faith in a strong, low-risk financial system to the test

“IDIOSYNCRATIC”

Fed officials have been surprised to some degree by how little turmoil their rate increase has triggered until now, with some policymakers saying the lack of clear stress made them more inclined to keep raising rates as they work to tame inflation.

That may change now, with some analysts suggesting it could tilt the Fed toward a lower endpoint in its rate-hiking cycle.

The initial sense was that SVB’s problems were “idiosyncratic”, as Bank of America analysts put it, with others noting that markets still looked at the largest financial institutions as immune from fallout. Those firms in particular are buffered by the higher levels of capital under reforms enacted a decade ago to cushion them against failure.

When it was closed Friday, SVB had a balance sheet of about US$200 billion and was the country’s 16th largest bank. That is far from the league of the large, systemic players, but big enough to rattle the stock prices of other mid-sized institutions and prompt calls for depositors to be protected beyond the Federal Deposit Insurance’s standard US$250,000 limit.

The concern was the type of herd behaviour that might develop if SVB’s depositors faced losses, and confidence began to erode more broadly.

The Fed’s response was described by Fed officials as classic central banking, lender-of-last-report behaviour – offering funds on a virtually unlimited basis against safe collateral.

But it also was framed by the lessons and restrictions of prior crisis. The situation had to be judged systemic, a finding unanimously endorsed by the Fed’s Board of Governors, Treasury Secretary Janet Yellen, and others.

Its structure was meant to match the size of the problem, potentially big enough, Fed officials said, to match all currently uninsured deposits – which amounted to more than US$9.2 trillion across the banking system at the end of last year – should account holders march en masse to their bank and demand their money.

Yet it also highlighted the still limited scope regulators have on how and where potential crises may develop.

SVB’s collapse appears driven by the sort of rate and funding dynamics the Fed watches for in semiannual reports devoted to financial stability and in documents like the Monetary Policy Report to Congress delivered earlier this month.

In its report to Congress on Mar 3, that funding risk was judged “low” in the system overall.

“Large banks continue to have ample liquidity to meet severe deposit outflows,” the Fed report said. “Against the backdrop of a weaker economic outlook, higher interest rates, and elevated uncertainty over the second half of the year, financial vulnerabilities remain moderate overall.”