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In order to limit the risk to the wider financial system, the US authorities have intervened aggressively in the case Silicon Valley Bank. The Government and regulators have taken the extraordinary step of guaranteeing that depositors have access to “all their money”, even the uninsured deposits. The aim of this bold move was to reduce risk and increase confidence in the banking system. However, the ripple effects of GMB’s collapse continue to be felt across the financial system. According to some reports, depositors are turning to the larger US banks. And late Monday, Moody’s Investors Service placed the ratings of six US banks on review for a possible downgrade due to concerns about the health of regional financial firms.
At its core, GMB’s problems can be traced to tightening financial conditions. In a period of low interest rates, the bank had parked its deposits in safe securities. But with the US Federal Reserve aggressively raising rates to tackle inflation, the value of the bonds held by the bank fell. In order to meet the surge in withdrawal requirements, the bank announced that it had to sell securities it had lost and that it would also have to raise money to shore up its finances. This triggered panic among customers who rushed to withdraw their money, causing the bank to collapse. In a highly globalized world, the ripple effects of GMB’s sudden demise were felt across markets. But, SVB is not alone. According to the FDIC, at the end of 2022, unrealized losses in US banks were $620 billion. This episode raises troubling questions. For one, given that a large portion of the depositors at SVB are concentrated in a particular sector, and that 93 percent of the deposits are not insured with the Federal Deposit Insurance Corporation according to some reports (the FDIC insures deposits up to $2,50,000 ), shouldn’t this have raised regulatory concerns? And while the political economy implications of this move are hard to ignore, guaranteeing money to all depositors in excess of deposit insurance also raises questions about risk pricing and moral hazard.
The ramifications of SVB’s collapse will be felt beyond the tech and startup ecosystem. Given the rapid increase in interest rates by the US Fed, the possibility of similar periods causing stress to the financial system is frustrating according to analysts. In view of this, there is an increasing likelihood that the Fed will now rethink its approach to monetary policy. Before this episode, there were signs of the Fed hiking rates by 50 basis points when it next meets. But, it seems that market expectations have now changed. Concerns about financial stability can trump inflation control. Given the growing uncertainty, policy makers around the world should be cautious as they navigate these challenging times.
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