Snowball Effect:

The closure of Silicon Valley Bank (SVB) marked the largest banking collapse since the 2008 failure of Washington Mutual, which was followed by a financial crisis that crippled the US economy for years. That collapse prompted decision makers at the time to impose stricter capital requirements for US banks to ensure that the collapse of individual banks would not affect the financial system and economy as a whole.

However, these requirements did not prevent SVB’s announcement from having far-reaching economic repercussions. The bank had announced that it needed to take immediate steps to improve its finances and filed for bankruptcy following lukewarm trading on Thursday, 9 March 2023 and Friday, 10 March. But rather than mild impacts, the news provoked a huge wave of fear in the banking sector and in the US economy more broadly, as well as in international markets. Financial analysts and experts indicated that this was the first bear market following two years of outperformance in the main indices. Growth had lasted for almost a decade following the global financial crisis of 2008.

Immediate Aftershocks

Although Silicon Valley Bank is a relatively small lending business, financial markets experienced immediate aftershocks after news of the bank’s collapse. These included:

1. Ramifications of SVB’s closure for other US banks: The failure of SVB caused major shocks in markets due to fears of market upheaval and repercussions for other lenders. The falling markets forced other banks to shut down. On the morning of Monday, 13 March, regulators closed Signature in New York, a leading crypto bank, and placed it into receivership after it fell 23%. Meanwhile, Western Alliance Bancorp recorded losses of more than 20%. According to Reuters estimates, US banks lost a total of more than $100 billion in stock market value over the two-day period following the closure of SVB, while European banks lost another $50 billion.

2. US stocks fall: US stocks fell after the SVB shutdown as a result of shocks to the market. All major indices slipped at least 1%. The Dow Jones Industrial Average fell by 1.07%, while the Nasdaq Composite fell by 1.76%. The S&P 500 experienced its largest weekly drop this year and plummeted 1.4% that day and 4.5% over the course of the week. The KBW Bank Index, which includes 24 major banking stocks, also dropped significantly.

3. European bank stocks slip: Following the news of SVB’s closure on Friday, March 10, the Paris stock market fell 2.9%, while the Frankfurt Stock Exchange fell 3.04% and the London Stock Exchange dropped 2.58%. European bank stocks slipped more sharply: BNP Paribas fell by 6.8%, Société Générale by 6.2%, Credit Suisse by 9.6%, and the German bank CBKG by 9.9% in two sessions. This drove down the benchmark index for publicly-listed European banks by 10.2%, while the STOXX Europe 600 slipped 1.35% after a 3.9% drop in bank stocks.

4. Credit Suisse hard hit: The European banking giant Credit Suisse, which has assets around the world, was hard hit by the market upheaval. The bank indicated that it had found certain "material weaknesses" in its financial reporting. It was not clear at the time whether the European Central Bank would be able to rescue Credit Suisse. This sent financial markets into a state of panic, although the Swiss National Bank intervened at the right moment and provided liquidity of around $53.7 billion to Credit Suisse in order to assuage European investors’ fears. According to a statement issued by the Swiss National Bank, Credit Suisse would repurchase about $3 billion of debt. However, this did not resolve the crisis. On 19 March, Swiss bank UBS offered to buy Credit Suisse in a billion-dollar deal. The Swiss government is expected to amend its banking laws in order to facilitate the takeover.

5. Treasury yields drop: In order to avoid stock market risks, many investors turned to government bonds as a safer choice in the wake of SVB’s bankruptcy. This caused a major drop in treasury yields, which moved in the opposite direction as stocks. Germany’s two-year bond yield, which is seen as a benchmark for the euro zone, dropped by about half a percentage point during the day that the SVB was shut down.

6. US banks turn to Federal Reserve: US banks flocked to the Federal Reserve Board’s liquidity facilities in an unprecedented fashion during the week following the closure of the SVB. The Federal Reserve’s weekly balance sheet indicated that it had provided about $153 billion in loans during the discount window, which was higher than at any time during the 2008 financial crisis.

Temporary Recovery

Financial markets have experienced an uneasy stability after the rapid intervention of the US government. After SVB, Signature Bank, and Silvergate Capital experienced huge financial problems, the US Federal Reserve Board, Department of the Treasury, and Federal Deposit Insurance Corporation (FDIC) announced a 25-billion-dollar Bank Term Funding Program. The program, which was launched on Sunday, March 12, provides loans for up to one year to struggling financial institutions under easier terms than usual. It aims to prevent potential worse-case scenarios such as a rapid and uncontrollable collapse extending to the rest of the financial system, starting with regional banks, which are seen as weaker and more susceptible to broader economic trends.

Markets were also calmed by US President Biden’s reassuring speech at the White House on 13 March, in which he promised American depositors that they would be able to access funds if their bank collapsed. This helped calm fears of more wide-scale bank liquidation and had a positive effect on the stock market.

Regional bank stocks in the US rose on 14 March, with financial markets less anxious about the SVB crisis. Investors began to feel more confident that the SVB collapse would not result in a broader financial crisis. San Francisco-based First Republic saw its stocks rise by 44% to slightly more than 45 dollars per share, shortly after markets opened. Meanwhile, PacWest in Beverly Hills rose by 46% to 14 dollars per share, while Arizona-based Western Alliance rose 27% to 33 dollars per share. Regional banks also showed signs of recovery that day: KeyCorp in Cleveland saw its stocks rise by 15%, Comerica in Dallas rose by 5%, and Huntington Bancshares in Columbus was up 8%. The S&P 500 (SPXBX) also saw modest gains after on 16 March, after slipping 15% over the course of a week.

At the same time, the "four big banks" in the US, which had lost a combined $55 billion in market value after SVB collapsed, showed improvement when markets opened. JPMorgan Chase and Bank of America climbed 1%, while Wells Fargo rose 4% and Morgan Stanley was up 3%.

Market Anxieties

Rebounding financial markets or an upswing in stocks does not mean that the crisis is over. Financial markets are very sensitive to any changes or incidents that could arise and which could affect investor confidence, and prompt investors to buy or sell. This is especially true in light of ongoing concerns related to the following issues:

1. Banks likely to feel effects of rising interest rates: Banks will face risks from raising interest rates during the coming period, which is expected to contribute to reduced investment assets for those banks. This could in turn lead to funding challenges. According to Lauren Goodwin, an economic expert with New York Life Investments, rising interest rates could result in an economic slowdown, which could affect US economic performance. Goodwin cited what is happening in the banking sector as evidence of investor fears that the collapse could spread to other parts of the economy, if interest rates continue to rise.

2. Concerns about fallout of rescuing depositors: Some analysts argue that US financial institutions and the Biden administration’s decision to rescue uninsured depositors in the SVB, as well as the Federal Reserve Bank’s decision to offer increased liquidity, could temporarily prevent one crisis by causing another.

Rescuing depositors resulted in a chaotic monetary policy for the Federal Reserve and volatile stock markets. This led to temporarily halting trading in a number of interest contracts in the futures market. Meanwhile, the two-year treasury yields, which are particularly susceptible to interest-rate expectations, fell from 5% to less than 4%. The US has not seen that kind of drop since the stock market collapse in October 1987.

3. Increasing uncertainty about Federal Reserve’s monetary policy: Increasing uncertainty has resulted in tightening liquidity in the US Treasury market, which is considered a cornerstone of the global financial system. This state of affairs could provoke unprecedented fluctuations in Treasury markets, in light of forecasts that the Federal Reserve will halt or slow price hikes to avoid increasing pressure on the financial system. Uncertainty about where the Federal Reserve’s monetary policy is headed has also exacerbated investor anxieties. It is unclear whether it will continue to raise interest rates or announce a temporary halt in interest rate hikes when it meets on 21-22 March.

4. Growing fears about credit stress: It seems that anxieties about credit stress are only increasing. The CDX—a basket of credit default swaps that serves as a benchmark for credit risks in North America markets—experienced its largest gap since late last year. Investors are counting on deteriorating credit quality. However, the index remains lower than it was in 2020, when markets were under the control of the COVID-19 pandemic, or during the financial crisis fifteen years ago.

5. Fears of a recession in the banking system: Markets have also reflected fears that pressures on the banking system could cause an internal recession within it. Economically fragile assets such as oil and small-cap stocks (the RUT index) have fallen since the SVB’s difficulties made headlines on 8 March. Gold stocks, which are seen as a safe haven in difficult times, have risen more than 5% during this period. Meanwhile, VIX, the volatility index, reached its highest levels since last October. Crude oil prices struggled to gain any ground on 16 March, as fears about financial stability forced market participants to adopt a more conservative approach with regard to potential increases in demand this year.

6. Market volatility likely to persist: Leading Wall Street indices fell significantly on 16 March, after a report that some major US banks were holding talks to reach a deal with the First Republic Bank. This report was released after the European Central Bank raised interest rates by around 50 basis points. That decision, which occurred prior to 16 March, dealt another blow to investor morale, which had already been weakened by concerns about the banking crisis. As a result, European stocks lost their previous gains. The European Central Bank’s decision to drive up interest rates by 50 basis points during the Credit Suisse and US banking crisis further undermined investor confidence in the banking sector in the region. Other stock markets ended a string of losses which had lasted for five days. The Benchmark Sensex made up for its losses and was up 78 points when it closed, due to investors buying value stocks in banks and energy. Nifty closed with modest gains at 17,000.05 on 19 March.

In conclusion, indices suggest that bond market volatility could rise to its highest levels in three years, even beyond where it stood during the March 2020 financial crisis at the beginning of the COVID-19 pandemic. At that time, the market froze and did not thaw again until $4 trillion was pumped into the market by the Federal Reserve. Meanwhile, European markets have been less anxious after a difficult week thanks to the Swiss National Bank’s intervention. Concerns remain and debate is ongoing regarding the deal to buy out Credit Suisse, especially given growing fears about the economic impact of the European National Bank’s decision to tighten its monetary policy.

It is worth noting that financial crises result in demand destruction. This prompts banks to reduce credit availability as consumers stop making large purchases, companies postpone expenditures, and investors sell quickly to avoid losses. All of these factors contribute to exacerbating instability in markets. Therefore, even if it appears that the crisis is over, the root of the matter still urgently needs to be addressed in order to produce real stability in financial markets.