Highlights:

• The crisis faced by Silicon Valley Bank (SVB), and Signature Bank, is a classical bank run – in the digital era.
• A large part of the risk seems idiosyncratic, as high duration assets and exposure to the technology sector made the banks particularly vulnerable to the sharp increase in rates.
• Yet with nearly 90% of affected bank deposits unprotected by the Federal Deposit Insurance Corporation (FDIC), the risk of contagion was still high, triggering the Fed and US Treasury to step in with a new generous liquidity support program and an extension of the protection to large depositors at all banks.
• This is a major step to contain the market rout and prevent it from spilling over to healthy institutions, while (again) raising  moral hazard concerns for the future. Yet the crisis will create further headwinds to the US financial system, fanning the battle for bank deposits (in the context of intense competition from money market funds), leading to a greater  concentration of deposits in the favour of large banks, and limiting the provision of credit to the wider econ-omy. The systemic component of the crisis lies in the large amount of unrealised losses across financial institutions – not just banks – which creates an inherent fragility, especially in the case of suddenly rising liquidity needs.
• These events will further complicate the job of central banks, as they still seek to tame inflation. The joint tightening of  financial conditions and lending standards does increase the recession risk. Barring a further escalation of the stress over the coming days, we still expect the Fed and ECB to envisage further rate hikes in March. A 50bp hike by the Fed appears highly unlikely, but we still deem a 25bp move more likely than a pause.
• The events add to the case for maintaining a prudent exposure to risk assets for now, while US Treasuries still have appeal as a good hedge against financial market stress.
• European banks also suffer from greater investor scrutiny, but overall appear better positioned than their US peers on various risk and valuation measures.
   

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