NO financial news can be more unnerving than the seizure of California’s Silicon Valley Bank (SVB) followed by the closure of New York’s Signature Bank two days later.

US regulators’ prompt action in seizing SVB and ensuring that all insured and uninsured deposits are fully redeemable has largely calmed the financial market.

Although the banking disaster is reminiscent of the 2008 subprime misadventure that turned into a global financial crisis, the two are different in terms of root cause and transmission mechanisms.

What happened to SVB was a laggard risk re-orientation in the face of interest rate hikes.

During the tech heyday in the Covid years, SVB, which serves more than half of the Silicon Valley start-ups, witnessed a huge influx of deposits. The funds were invested in long-term treasury bonds.

Despite being lower yielding, bonds were safe and rewarding enough to finance the even lower cost of deposit in a time of near-zero interest. The interest rate spreads simply were in their favour.

The financing environment changed rapidly, however, when the Fed started raising interest rates in March last year.

While the stock of assets is stuck in lower-yielding treasury bonds, the cost of deposit financing has risen dramatically within a short period of time. The interest rate spreads now work against their favour.

This is especially true as institutional deposits, which constitute the majority of SVB’s funds, are far more sensitive to interest changes.

Unless the bank pays proportionally high deposit rates, institutional depositors can vote with their feet. This gives the bank very little room to re-orient its asset risk portfolio.

The consequences, now we know, can be very damaging. The bank is already in the red in terms of yield spread and was forced to make a further loss when it had to sell the lower-yielding bonds at a lower price (since bond rates have gone up) to meet withdrawals as the depositors, mainly venture capitalists and their sponsored start-ups, whose deposits are uninsured as they typically exceed the insured threshold, rush to cash out.

This is a different situation from the 2008 global financial crisis.

Major banks, which are well capitalised and diversified, or the American households are involved.

There is no spider web of investors worldwide, as there was back then with toxic mortgage-backed securities, as the financial connectivity is limited within the resourceful tech ecosystem.

The soil for systemic risk is absent and thus the risk of a global spillover.

Alas, even when history does not repeat itself, it sometimes rhymes.

Two decade-old issues re-emerge. The first is about banking regulation.

Financial de-regulation in the 1990s was viewed as one of the reasons that brought America to the financial meltdown in 2008. The Dodd-Frank Act was enacted in the aftermath of the crisis to promote financial stability and put an end to the premise of banks being “too big to fail”.

But the act was repealed under the Trump administration following the massive lobbying of regional banks – like SVB and Signature Bank. 

So will a new bill be introduced to tighten up banking regulation to reduce risk concentration? It’s probably a long shot, though worth looking into.

The question now is whether the Fed should, and would, pause the interest rate hikes.

It is certainly not the first time the Fed has had to worry about the financial consequence of the interest rate policy. In the 1990s, the debate was about whether the US central bank should raise the interest rate to prick the asset price bubble.

In the 2010s, it was whether the Fed was easing its monetary policies too much for too long, creating bubbles everywhere.

In the end, the consensus is to let macroprudential policies take care of the financial spillovers while the Fed keeps its eyes on the real economy.

Now, the dilemma comes back haunting.

Staying the course until the inflationary curve isf bent may come at a cost of financial peril at best, an extreme winter for tech start-ups and a hard landing at worst.

Pressing the brake pedal, however, could undermine the disinflationary effort, putting the Fed’s credibility at risk.

Is the consensus equally applicable now? We will find out soon. – March 16, 2023.

* Wong Chin Yoong is a professor of economics at Universiti Tunku Abdul Rahman, Kampar campus.

* This is the opinion of the writer or publication and does not necessarily represent the views of The Malaysian Insight. Article may be edited for brevity and clarity.