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SVB’s collapse could lead to ‘contagion’ among regional banks—but experts say it’s not a systemic risk to the entire financial system

And the cracks begin to show…

The start-up-focused Silicon Valley Bank (SVB), collapsed this week. It was the second largest bank to go under in U.S. history, only behind the 2008 blow-up of Washington Mutual during the Global Financial Crisis (GFC). Regulators at the California Department of Financial Protection and Innovation closed SVB and took control of its assets Friday after depositors—which were mainly struggling tech start-ups—began a run on the bank. The FDIC has been named as the receiver.

The trigger came when the SVB’s parent company, SVB Financial, failed to raise over $2 billion in emergency capital on Wednesday to strengthen its ailing balance sheet. Shares of the company plummeted more than 60% the following day, and trading was halted Friday after another double digit plunge during pre-market hours.

The fallout for the venture capital world from SVB’s issues is likely to be severe. The bank has said it had relationships with more than 50% of all venture-backed companies in the U.S., and some 93% of its $161 billion in deposits are uninsured. “If those accounts get frozen, deals can’t get met, software can’t get paid for—these kinds of delays, even by a few weeks, can be really catastrophic for business,” one venture investor told Fortune Thursday.

Tech and start-up focused banks, as well as regional banks, could face serious “contagion” risk following the collapse of SVB as well, Larry McDonald, founder of The Bear Traps Report, told CNBC late Thursday. But most experts believe that SVB’s issues aren’t a signal of systemic risk for the financial system as a whole due in part to strict regulations adopted after the GFC.

“We do not believe there is contagion risk for the rest of the banking sector on the heels of SVB's struggles,” David Trainer, CEO of the investment research firm New Constructs, told Fortune Friday. “The deposit base from the major banks is much more diversified than SVB and the big banks are in good financial health.”

Top economists including former Treasury Secretary Larry Summers and Queens’ College, Cambridge President Mohamed El-Erian were also quick to assure consumers that the overall financial system isn’t in trouble.

“I don’t see—if this is handled reasonably, and I have every reason to think that it will be—that this will be a source of systemic risk,” Summers told Bloomberg Friday.

“Contagion risk and the systemic threat can be easily contained by careful balance sheet management and avoiding more policy mistakes,” El-Erian said in a subsequent tweet.

Regional banks’ ‘contagion’ risk and SVB-specific issues

Regional banks are facing pressure from SVB’s blow-up for two main reasons. First, venture capitalists and start-ups that rely on these banks are worried. CNBC reported Friday that one venture capitalist said it was like someone shouted “fire in a crowded theater where there is no fire,” leading many businesses and tech investors to ask for their money back from banks just to be safe.

There is already some evidence of contagion to regional banks as a result of this fear. Trading in multiple regional banks stocks including PacWest Bancorp, Western Alliance Bancorp, and First Republic Bank was halted Friday amid aggressive selling from investors.

The iShares U.S. Regional Banks exchange traded fund, which tracks U.S. regional bank stocks, also cratered over 8% Thursday after the SVB news broke. And on Friday, it was down another 5% plus.

Chart shows bank stock price changes since March 8, 2023
Chart shows bank stock price changes since March 8, 2023

While regional banks’ stocks—as well as the shares of crypto or tech focused lenders—were particularly affected by SVB’s issues this week, even the KBW Nasdaq Bank Index, which tracks large cap bank stocks, sank 7.7% on Thursday vs. a 1.7% drop in the S&P 500. And shares of JPMorgan Chase, Bank of America, and Wells Fargo fell 5.4%, 6.2%, 6.2%, respectively on Thursday alone.

Aside from potential direct contagion from SBV’s collapse, some of the bigger market forces that hurt the bank are also affecting other lenders, sparking concerns over some regional banks’ ability to cover losses related to their bond holdings in a rising rate environment. Many U.S. banks invested in long-duration Treasuries during the pandemic when consumers pumped money into savings accounts like never before. The problem is that the value of these bonds has dropped dramatically with the Fed raising interest rates over the past year, leading U.S. lenders to hold $620 billion in unrealized losses in their portfolios.

Fed officials’ aggressive interest rate hikes have also led banks’ deposit growth to slow dramatically, as consumers can now use U.S. treasuries as a safe alternative to store their cash and earn a real yield. Major U.S. banks have responded to this dilemma by raising the interest rates on certificate of deposits (CDs). JPMorgan Chase CEO Jamie Dimon even told investors in a January earnings call that he has been forced to begin aggressively “competing” for consumer deposits.

Some experts now fear that as interest rates continue to rise and deposit growth slows, regional banks will experience issues with their balance sheets akin to what was seen at SVB—and those issues could even spill over into other areas of the financial system. "In essence, the Fed is causing this bank run," McDonald said.

Little chance of wider contagion

Still, Mark Haefele, chief investment officer at UBS Global Wealth Management, said he does not see any “classic signs of contagion” from SVB’s collapse to the wider financial system. And he noted that the $620 billion of estimated unrealized losses at U.S. banks need to be put into context. U.S. lenders also have total equity holdings of $2.2 trillion, and total realized losses from portfolios last year were just $31 billion, even though the S&P 500 sank 20%.

Bank of America analysts, led by Ebrahim Poonawala added in a Friday research note that they believe the sell-off in bank stocks was overdone, arguing that “investors extrapolated idiosyncratic issues at individual banks to the broader banking sector.” New Construct’s CEO David Trainer noted that rather than an indictment of the wider financial system, many of the problems SVB is facing are really evidence of the dangers of doing business with “bad companies.”

“Many tech startups are actually zombie companies with no business models and aren't worthy of receiving any kind of loan. SVB is now learning this the hard way,” he said, arguing the bank should have been more “discerning” about their clientele. “The market has been punishing companies that have no business models since the bear market began in January 2022 and SVB's woes are the latest frontier in the market's reckoning.”

Still, while most experts believe that contagion from SVB’s collapse is unlikely, economist David Rosenberg warned that many analysts and economists were equally sure that there was no systemic financial risk prior to the GFC in 2008.

“Talk about how SVB is a one-off reminds me of all those shoulders that shrugged in ‘07 when New Century Financial shuttered,” he wrote in a Friday tweet, referencing the prelude to the GFC. “It’s as if the word contagion doesn’t exist for some people.”

Jay Hatfield, CEO at Infrastructure Capital Advisors, also told Fortune that the Fed’s rapid rate hikes are already “leading to bank runs” outside of SVB.

“The Fed is in the process of another major policy error by raising the Fed funds rate way too high without pausing to assess the impacts of the record increases over the last year,” he warned.

A Fed pivot?

While fears over contagion to the financial system from SVB’s collapse are certainly rising, some experts argue that the blow-up may give the Fed a reason to consider slowing the pace of its interest rate hikes, which could benefit investors and consumers.

“The Fed now has very clear evidence that they are having an impact on the financial system and the economy—rate hikes are starting to bite—and while that’s not enough to give them pause, it is something they will take into consideration,” UBS’ Haefele said.

Gina Bolvin, President of Bolvin Wealth Management Group, added that the Fed will be closely monitoring for any signs of “contagion risk” to the financial system, which could lead to rate cuts this year.

“We’re even seeing the odds of a rate cut at 50/50 for December,” she told Fortune, but she noted that it’s not all good news. “There's a receding probability that more hikes are coming, but for the wrong reason: recession fears and implications from what’s happening in the banking space.”

March 10, 2022: This story has been updated to reflect that the FDIC has been named as the receiver of SVB.

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