Why recent bank failures are unlikely to trigger a broader crisis in the US

Silicon Valley Bank’s (SVB) recent failure has brought widespread attention to the durability of the global banking system and sparked concerns about a possible crisis reminiscent of the 2007-2008 Global Financial Crisis. While anxiety over bank failures is understandable, Morgan Stanley Wealth Management believes SVB’s collapse does not represent an immediate threat to other institutions and that a widescale bank run is highly unlikely in the US. Here’s why and considerations for investors:

Morgan Stanley Wealth Management believes SVB’s failure emerged from the bank’s poor management, leading to a self-inflicted crisis stemming from four main factors:

1. Most of SVB’s deposits came from a narrow base of customers and were largely uninsured. To manage risk, many banks attempt to have a diversified depositor base, including individuals and corporations across multiple industries. However, SVB received most of its deposits from technology start-up ventures. What’s more, customer accounts tended to hold large amounts of business operating cash—for things like paying salaries or buying and selling inventory—and, thus, were continually being drawn down. More than 90% of the bank’s accounts exceeded the Federal Deposit Insurance Corporation’s (FDIC’s) insured limit of $250,000, likely in part because accounts held cash related to running a business.
2. Most of SVB’s assets were concentrated in securities vulnerable to interest rate hikes. SVB held a large share of its earning assets in securities, largely in long-term Treasuries and mortgage-backed securities. This portfolio had grown, along with significant deposit inflows, amid record-low yields in 2020 and 2021. However, as the Fed rapidly raised interest rates to help tame inflation in 2022, SVB experienced deep unrealized losses on those securities. (Debt securities tend to decline in value as rates rise.) As customers began withdrawing deposits en masse, SVB was forced to sell these securities at depressed prices, triggering its own insolvency amid the sizable outflows.
3. Ineffective risk management. Banks typically appoint chief risk officers to monitor and effectively check the risk-taking activities of other business leaders. SVB did not have a chief risk officer for eight months, starting in April 2022. During that time, as rising interest rates prompted unrealized losses in SVB’s securities, its depositors were continually using up their cash reserves, often while not yet generating profits, amid a softening environment for venture fundraising and dealmaking that might have otherwise helped ease their cash needs.
4. Lack of stringent regulatory oversight. SVB faced a lower degree of regulatory scrutiny than larger, more complex banks. (The regulatory framework shifted in 2019, reducing scrutiny for banks with SVB’s asset base.) Without such oversight, SVB faced a worsening mismatch between its liabilities (the deposits customers needed to withdraw) and the assets it had to fund those liabilities (its long-term debt securities that had declined steeply in value).

Could a similar crisis befall much larger US banks?

Morgan Stanley Wealth Management believes there is a very low likelihood of a bank run for any of the so-called globally systemically important banks (G-SIBs) in the US. Here are a few reasons why:

• Due to their rigorous stress-testing requirements, US GSIBs must consistently verify their ample capital reserves, even in adverse scenarios.
• US-GSIBs have carefully managed their loan books in recent years. Banks have also tightened mortgage and commercial lending standards in recent quarters.
• Unlike SVB, most regional banks and US G-SIBs benefit from a diverse depositor base and do not rely solely on deposits as a source of liquidity.

In addition, the Fed is backstopping uninsured deposits at failed banks, which sharply diminishes the threat of any bank becoming overwhelmed by customer withdrawals. Also, the creation of a Bank Term Funding Program (BTFP) essentially eliminates the need for banks to sell high-quality securities at a loss to meet deposit withdrawal shortfalls.

Importantly, SVB’s failure is different from the 2007-2008 financial crisis, when solvency concerns arose given lower-quality assets on financials’ balance sheets.

As Morgan Stanley Wealth Management Chief Investment Officer Lisa Shalett noted last week, the odds of a recession have increased. Should conservatism be the response of the banks to this crisis, then slower lending, reduced risk taking, and weaker access to capital could hasten insolvency for unprofitable startups. This could lead to a pullback of consumption and an increase in savings rates, with the labor market potentially beginning to exhibit signs of cracking.

Morgan Stanley Wealth Management thinks investors should focus on quality yield growth at a reasonable price and earnings potential—attributes that can be found in health care, select semiconductors and software, financials, energy, and materials/mines. Real assets like gold remain a decent hedge for a recession and stagflation.