Idiosyncratic vs. Systemic


March 14, 2023

  • Over the weekend, federal regulators moved quickly to guarantee deposits at failed Silicon Valley Bank
  • The new Bank Term Funding Program (BTFP) is designed to provide liquidity for banks during times of stress.
  • In our view, the idiosyncratic risk associated with SVB may not result in a systemic risk event for the larger banking industry.

Following Silicon Valley Bank’s (SVB) insolvency there is a lot of speculation and uncertainty in the financial sector as investors (and depositors) try to assess the health of smaller regional and larger money-center banks. In our view, a key issue involves the question of the SVB risk being company-specific (termed idiosyncratic) or industry-wide (termed systemic). We believe the SVB situation included more idiosyncratic risk but also exposed a certain level of systemic risk for the banking industry.

On the idiosyncratic side, SVB’s primary customer base of venture capital, IPO, and other start-ups resulted in significant deposit growth between 2019 and 2021. However, deposits dried up with a slowing economy and multi-year lows in capital funding for IPOs and start-ups. With venture capital and next-round funding drying up and thus no new cash for start-ups, deposit growth turned negative as companies burned through cash to fund daily operations. In our opinion, this scenario reflects the company-specific risk that befell SVB and is not necessarily representative of the larger banking industry. The graph at the right illustrates the nation’s largest banks based on assets.

However, on the systemic side, SVB (and many other banks) used customer deposits to fund purchases of longer-dated Treasuries and government agency securities, which are considered low risk if held to maturity. It is noteworthy that, as a whole, the banking industry does not appear to be acting “recklessly” with customer deposits by purchasing low-quality securities with exotic features. However, the rapid rise in interest rates induced by the Federal Reserve to help quell inflation has resulted in bonds classified as held to maturity (HTM) being valued at much lower levels than their original purchase price.

Read the full report.