Why has trading stopped at some banks and will the SVB contagion spread?

Fears of financial contagion triggered by the collapse of Silicon Valley Bank spread on Monday as shares across the sector plunged.

Such was the panic that trading at at least 20 regional banks had to be temporarily suspended as the value of their shares fell by as much as 80 percent.

The disappearance of SVB in the middle of a run on the bank, which meant it could not cover customer withdrawals, raised fears that other small and medium-sized institutions could be at risk. President Joe Biden and Treasury Secretary Janet Yellen have been forced to take the highly unusual step of issuing statements saying the banking industry is safe.

While analysts say the saga is unlikely to trigger a broader financial crisis on the scale seen in 2008, the unrest could continue as fallout effects unfold.

The collapse of SVB and fears for other banks are inextricably linked to the aggressive rate hikes by the Federal Reserve. Analysts now also believe that plans to raise rates again this month could be halted to avoid further turmoil.

Why was trading stopped at at least 20 other banks?

Shares in more than a dozen regional banks plunged when the market opened on Monday.

The rapid fall in their prices caused the trading of shares in these institutions to stop. These “circuit breaker trading interruptions” are triggered when a price falls rapidly, with the intent of controlling panic selling and avoiding a complete crash.

Investors rushed to sell shares in the banks fearing they would face the same problems that led to the collapse of SVB.

SVB failed because it did not have enough cash to cover consumer withdrawals. This was partly because they had used a large part of customer deposits to buy Treasury bonds.

These bonds are generally considered safe, but the value of SVB’s bonds suffered after the Fed raised interest rates to cope with rising inflation. SVB was forced to sell these bonds at a loss of nearly $2 billion to increase its liquidity.

Investor concerns that a similar situation could be playing out at other banks arose after the head of the Federal Deposit Insurance Corporation, which insures deposits at failing banks, said banks across the United States have $620 billion in “unrealized losses.”

Will the contagion continue to spread?

Silicon Valley Bank primarily served startups in the technology sector. Analysts say that while this niche has made its collapse potentially fatal for new and growing tech companies that used the bank, it has softened the impacts for the broader banking sector.

Karen Petrou, managing partner at Federal Financial Analytics, told the Washington Post: ‘It’s extremely painful. It could have very adverse consequences: microeconomic damage, damage to social welfare. People could suddenly be in the creek. But that is not systemic. I don’t think we are at risk of a crisis.

But while SVB served a niche client base, the problem it faced due to inflation and interest rate hikes exists throughout the banking sector, as highlighted by the warning of a $620 billion black hole. .

That means it could take some time to restore confidence in the industry.

It also remains to be seen whether measures unveiled by regulators, including a $25bn loan program for other struggling banks, will ease fears.

Most analysts agree that the biggest US banks, including JPMorgan Chase, Bank of American and Wells Fargo, are highly unlikely to face problems on the scale that SVB feels. While shares in these institutions have also fallen, they have cash reserves in the hundreds of billions of dollars that make a run on the bank extremely unlikely.

What about the Fed’s plan for another rate hike?

While Silicon Valley Bank’s failure can be attributed in part to mismanagement, the crisis is also linked to the Federal Reserve’s aggressive rate hikes.

As a result, some industry insiders say the Fed may halt plans to continue raising rates because of what happened.

The Federal Reserve has raised interest rates eight times in the past year to contain decades-high inflation.

This helped several lenders post healthy profits for 2022, but higher rates also lowered the value of bonds bought by banks when they had lower yields. SVB collapsed after suffering a $1.8 billion loss on the sale of $21 billion worth of securities.

Matthew Weller, head of research at Forex.com and City Index, said: “In the wake of the SVB implosion, traders are lowering their expectations for Fed hawkishness next week.” In other words, investors believe the Federal Reserve will ease further hikes.

Eric Vanraes, Portfolio Manager of Eric Sturdza Investments’ Strategic Bond Opportunity Fund, said: ‘For now, markets are not anticipating a Lehman Brothers-style panic, and based on existing data, that is a reasonable response.

‘If we were in a Lehman-style environment, the Fed would have cut rates by now. Instead, the Fed knows that any further rate hikes could trigger more bankruptcies in banks, hedge funds, pension funds, and the housing market.”

What is the government doing to manage the crisis?

The Federal Reserve, the US Treasury Department and the Federal Deposit Insurance Corporation decided to guarantee all deposits at Silicon Valley Bank, as well as Signature Bank of New York, which was seized on Sunday.

In essence, they agreed to insure all deposits, above and beyond the $250,000 insured deposit limit.

Many of the emerging tech clients and Silicon Valley venture capitalists had well over $250,000 in the bank. As a result, up to 90% of Silicon Valley’s deposits were uninsured.

Without the government’s decision to back them all, many businesses would have lost the funds needed to pay payroll, pay the bills, and keep the lights on.

The government has also introduced a Bank Term Financing Program backed by $25 billion in taxpayer money to help other struggling banks cover withdrawals.

The purpose of the extended guarantees is to prevent bank runs, in which customers rush to withdraw their money, by establishing the Fed’s commitment to protect the deposits of companies and individuals and calming nerves after a harrowing few days.

If all goes to plan, the emergency loan program may not actually have to lend a lot of money. Rather, it will reassure the public that the Fed will cover its deposits and that it is willing to lend a lot of money to do so. There is no limit to the amount banks can borrow, apart from their ability to provide collateral.

But critics say the measures amount to a taxpayer-funded bailout.