SVB: Collapse puts Fed’s confidence to the test – 03/13/2023 – Market

Earlier this month, the Fed, in a report to Congress, gave what has become a standard guarantee: the banks were strong and the overall financial system was in good shape.

That confidence is now being tested as the Fed and other regulators watched last week’s Silicon Valley Bank collapse quickly turn into a potential systemic shock, threatening to undermine confidence in the banking system and trigger more runs on account withdrawals.

Just days after delivering the message of reassurance to Congress, the Fed released a crisis playbook enhanced during the 2008 housing meltdown and expanded during the Covid-19 pandemic, announcing its latest effort to keep the financial system stable.

Banks will now be allowed to borrow essentially unlimited amounts from the Fed, as long as the loans can be backed by safe government bonds, a way to avoid financial firms having to sell a class of investments that have been losing value because of high interest rates practiced by the Fed itself.

The regulators’ response on Sunday also included a promise to recover all depositors from the SVB, even those with accounts above the standard threshold of $250,000 from the Federal Deposit Insurance Corp. , Signature Bank, which went bankrupt over the weekend.

By allowing loans for one year against the full face value of government bonds and mortgage-backed securities, banks will be able to “easily leverage (the Fed’s new instrument) to access liquidity, rather than having to take significant losses and flood the paper markets” that are forced to sell to meet the demands of account holders, wrote economists at Jefferies.

“Monday will certainly be a stressful day for many in the regional banking sector, but today’s action dramatically reduces the risk of further contagion,” he added.

The Fed has permanent programs that are always available to shore up the financial system, including direct lending to banks with adequate collateral through its so-called discount window. The Fed made changes early in the pandemic to encourage such lending, some of which, including a reduced interest rate, remain in place.

But in this case, as in crises dating back to the housing meltdown of 2007-2009, the discount window was deemed inadequate to address the developing risks, problems that to some extent resulted from the Fed’s own aggressive monetary policies.

Understand SVB collapse

The collapse of the SVB highlighted whether aggressive rate hikes by the Fed, which took the rate from nearly zero a year ago to over 4.5% today, finally caused something major to “break” as Treasury bondholders low-income banks face capital losses and banks, especially smaller ones, face tougher conditions to raise deposits needed for their operations.

Fed officials have been surprised to some extent at how little turmoil the rate hike has unleashed so far, with some officials saying the lack of clear stress has left them more inclined to continue raising rates as they work to tame inflation.

That could change now, with some analysts suggesting this could push the Fed to a lower end point in its rate hike cycle.

The initial feeling was that SVB’s problems were “idiosyncratic,” as analysts at Bank of America put it, with others noting that markets still viewed the biggest financial institutions as immune to fallout. These companies, in particular, are protected by the highest levels of capital under reforms enacted a decade ago to protect them from collapse.

When it closed on Friday, SVB had a balance sheet of about $200 billion (R$1 trillion) and was the 16th largest bank in the United States. That’s far from the league of big names in banking, but it’s big enough to rattle the stock prices of other mid-sized institutions and call for account holders to be protected beyond the standard $250,000 limit. .2 million) from the Federal Deposit Insurance Corp.

The SVB collapse seems driven by the kind of rate and funding dynamics the Fed observes in semi-annual reports devoted to financial stability and in documents such as the Monetary Policy Report to Congress delivered earlier this month.

In its report to Congress on March 3, this funding risk was deemed “low” across the system as a whole.

“Large banks continue to have ample liquidity to meet severe deposit outflows,” the Fed report said. “In the context of a weaker economic outlook, higher interest rates and heightened uncertainty in the second half of the year, financial vulnerabilities remain moderate overall,” the Fed said at the time.

After SVB bankruptcy, US acts to reinforce confidence in the banking system

US officials launched emergency measures on Sunday to bolster confidence in the banking system after the failure of Silicon Valley Bank threatened to trigger a broader financial crisis.

After a dramatic weekend, regulators said customers of the failed bank would have access to all their deposits from Monday, and created a new instrument to give banks access to emergency funds. The Federal Reserve has also made it easier for banks to borrow in emergencies.

While the measures provided some relief for Silicon Valley companies and global markets on Monday, concerns about banking risks remain and cast doubt on whether the Fed will stick to its plan of aggressive interest rate hikes.

“We believe that the measures taken by the Fed, Treasury and (Federal Deposit Insurance Corp – FDIC) will decisively break the psychological ‘cycle of doom’ in the regional banking sector,” said Karl Schamotta, chief market strategist at Corpay.

“But fair or not, the episode will contribute to higher levels of volatility, with investors cautiously watching for further cracks to emerge as the Fed’s policy tightening continues.”

Regulators also moved quickly to close Signature Bank of New York, which had come under pressure in recent days.

The Biden administration’s intervention underscores how a relentless campaign by the Fed and other major central banks to curb inflation is putting pressure on the financial system and global markets.

SVB, a cornerstone of the startup economy, was a product of decades of cheap money, with unique risks that made it especially vulnerable. But with a run on the bank last week, concerns that other regional banks bear similarities to it quickly spread.

With the Fed poised to continue raising rates, investors said the financial system may not be entirely out of the woods just yet.

Goldman Sachs analysts said they no longer expect the Fed to raise rates by 25 basis points at its next policy meeting on March 21-22 amid stress in the banking sector.

The collapse of SVB — the biggest bank failure since 2008 — has raised concerns about whether small business customers will be able to pay their employees, with the FDIC only protecting deposits of up to $250,000.

About 89% of the $175 billion (R$906.7 billion) in deposits at SVB were uninsured at the end of 2022, according to the FDIC.

All depositors, including those whose funds exceed the government-guaranteed maximum level, will be recovered, according to a joint statement by US Treasury Secretary Janet Yellen; Fed Chair Jerome Powell; and Federal Deposit Insurance Corp President Martin Gruenberg; on Sunday night.