The world struggles to predict financial fallout from California bank collapse

As the millionaire depositors in Silicon Valley Bank got all their money back courtesy of a U.S. government agency, there were no doubt sighs of relief among those bank customers who would otherwise have taken a severe financial beating.

Until the U.S. government swooped in Monday, that included the vast majority of deposits at SVB, which catered to Silicon Valley startups and venture capital firms. Deposits over $250,000 US are uninsured by the Federal Deposit Insurance Corporation or FDIC.

Even the conservative-leaning Wall Street Journal, harking back to the hundreds of billions of dollars handed out following the 2008 banking meltdown, is debating whether the support for uninsured depositors in the second largest bank failure in U.S. history should be declared "a bailout."

One concern is "moral hazard," the concept that by handing out money to people who should have lost it in a free-market transaction means they will be reckless in future, and maybe their banks will be more reckless too.

But that is only one among many financial considerations suddenly altered by the unexpected capitulation of the pre-eminent banker to California startups.

Perhaps the biggest question raised by the collapse that has led to a ripple of selling across the global markets, including Canada, is why didn't we see this coming? Added to that is the question what other unexpected fallout there could be as the world contends with inflation and higher interest rates?

Libertarian ideologues in the venture capital community who might have quoted Ronald Reagan's famous bon mot, "The top nine most terrifying words in the English language are: I'm from the government, and I'm here to help," may turn down the money.

The U.S. Federal Deposit Insurance agency that effectively took over the assets of the failed bank moved quickly, announcing on Sunday that all insured depositors would have immediate access to their cash. By Monday it said uninsured depositors, those with more that $250,000 US, would also get their money back. But they said taxpayers would not be on the hook.

"Any losses to the Deposit Insurance Fund to support uninsured depositors will be recovered by a special assessment on banks, as required by law," said the Monday FDIC release.

Despite that quick action, bank shares around the world declined.

The Canadian Big Five were down between two and four per cent as the day began although they recovered most of their losses later in the day. Some smaller U.S. banks were hit harder as the FDIC and the U.S. government said its decision to reimburse uninsured depositors was a special case and would not apply to everyone.

Big bank failures are a worrying signal for all financial markets, but for banks in particular the way SVB collapsed was especially disquieting. And it all had to do with interest rates.

One key lesson for banks is that rising rates meant depositors in SVB had begun looking for a better return on their savings. That can be a problem for any bank because, while it seems only months ago there was too much money slopping around the economy willing to accept tiny rates of return, suddenly using and lending people's money may be getting more expensive.

It's sometimes easy to forget the essential rule that banks take deposits and then lend that money out over a longer term at a higher interest rate. If people start start withdrawing their deposits, as they did at SVB last week, the bank knows it cannot call in its loans fast enough to pay the depositors the cash it owes them.