On Friday, March 10, Silicon Valley Bank (SVB) went bankrupt, just 2 days after announcing difficulties.

What are the facts?

On Friday, March 10, Silicon Valley Bank (SVB) went bankrupt, just 2 days after announcing difficulties. This regional commercial bank is the 16^th largest U.S. bank. This is the biggest bank failure since the subprime crisis in 2008. Subsequently, two other U.S. regional banks defaulted, and other medium and small banks have similarities.

The rate hikes led by the Fed (nearly 5% in 1 year) to curb inflation, although having a positive impact on banks’ revenues, have mainly affected the value of fixed-rate bonds held by them. With the normalization of rates, investors wanted to recover their cash from current accounts with no or low remuneration to reinvest them at more attractive yield.

SVB Bank was forced to sell unhedged bonds to meet the $5bn of liquidity demand, with substantial losses ($1.8bn).

In addition, there is risk-taking on asset-liability management, allowed by lighter regulations for US banks whose balance sheet size does not exceed $ 250 billion.

Should we fear contagion?

To protect US technology companies, clients of SVB, the US central bank (Fed) and the Federal Deposit Insurance Corporation (FDIC), the two regulators of the US banking system, have sent an extremely strong message by putting in place:

1. An extension of coverage to uninsured deposits, beyond the regulatory $250,000
2. A 1-year liquidity support program, in exchange for securities at face value so that banks can cope with deposit leaks without crystallizing their losses.

In addition to the quick reaction of the Fed unlike 2008, the situation of the major American banks, and even more so in Europe, is very far from that of the subprime crisis:

1. Prudential rules have increased for large US banks (more than $250 billion in assets) and European banks with much higher levels of liquidity requirements.
2. European banks have diversified and stable deposits, hedge their bond exposures more widely and have stricter asset-liability management.
3. European banks largely withdrew from the US banking market after the 2008 crisis following tighter regulations.

We consider that the very specific nature of SVB (start-up financing with few stable deposits and weak regulatory supervision) and the responses of monetary and political authorities make it possible to remove the risk of contagion to the entire sector.

What are the impacts on the markets?

Volatility has made a comeback, particularly in the interest rate markets.

On Monday alone, German 10-year interest rates fell by 0.25%, by 0.10% in the United States and by 0.06% in Japan. US short-term rates (2 years) fell by 0.9% in 3 days, the third largest decline in 1 century.

The path reversed on Tuesday, with a rise of nearly 0.16% on the German 10-year.

Central banks’ terminal rate expectations have also been revised down to 3.30% for 6 months for the ECB (vs 4.10% 1 week ago) and 4.40% for the Fed (vs 5.70%).

The Credit market also tightened, with a spread of +50 basis points for the iTraxx CrossOver Index and +10 basis points for the iTraxx Main Index. These movements were mainly driven by senior and subordinated financial debt with +18 and +37 basis points respectively.

In the equity market, the US regional bank sector fell by -10% and -6% for European banks. The technology sector is holding up well following the Fed’s announcements.

 Can this bankruptcy call into question the pace of rate increases?

On the day of the announcement of SVB’s bankruptcy, interest rate markets relaxed, suggesting that investors were anticipating a temporary halt or even a decline in monetary tightening.

The unprecedented scale of the movement was fueled by very large hedge fund positions on the rise in the 2-year rate in the United States that had to be unwound urgently. This technical phenomenon will not be sustainable.

The inflation levels published on Tuesday, March 14 in the United States at 6% year-on-year do not show a sustainable slowdown in inflation. The same is true in Europe.

Inflationary forces, driven by a tight labour market and expansionary fiscal policies, are likely to maintain pressure on central banks, which should reaffirm their determination to continue the fight against inflation, even if the pace of interest rate hikes could slow.

Confidence in the banking sector is nevertheless fragile, as we have seen in many crises.  We remain very attentive to the risk of contagion to the rest of the banking sector, which is not our central scenario, but which would call into question the pace of rate hikes and growth.