How worried should forex traders be over the SVB crisis?

US stock indices dropped substantially yesterday, led by the Nasdaq and prompting a general sell-off across the world. A ~2% drop in the stock market isn't all that unusual, but this time it was caused by a massive drop in the banking sector. And when banks are in trouble, forex traders would do well to sit up and pay attention, since banks are the ones that handle all the money processing.

What happened?

The issue stems from some bad news out of a bank that is relatively unknown outside of the tech start-up sphere, Silicon Valley Bank, which is owned by SVB Financial (and most commonly known simply as SVB). It sparked a wave of panic in the tech sector, but also raised concerns among US retail banks that spread through all the major financial institutions. The cause of the crisis at SVB wasn't immediately apparent, and many investors are worried about the general situation of the banks as the Fed tries to drain liquidity from the market.

The issue came to light when SVB's parent announced that it had sold $21B in securities from its portfolio, followed by a filing to sell $2.25B in shares to shore up its capital position. The price of the stock subsequently crashed 60%, dragging on all the other banks. The reason was an unexpectedly high outflow in deposits from the bank. At the same time, SVB cut its net profit guidance.

What does it mean

What was already a problem of too many depositors withdrawing from the bank was accelerated when many venture capitalists started to pull their cash from the bank. Prominently that included Peter Theil's Founders Fund, which instructed its portfolio managers to limit exposure to SVB. The move caused what in effect was the first sign of a run on the bank. The CEO held a conference call with its main customers, trying to reassure them and avoid a full-blown run. A number of VCs have said they will stick with the bank.

The crisis at SVB coincided with the sudden closing of Silvergate Capital, which was highly exposed to the crypto industry. SVB is the only publicly-traded bank that focuses on Silicon Valley and its tech start ups. With interest rates rising, but inflation pushing real rates lower, tech startups in particular have been struggling to attract VC interest. That made SVB particularly vulnerable to a downturn in the tech space, as startups had to withdraw funds to keep operating in an increasingly costly environment.

What happens now?

The best case scenario is that the sale of assets covers the withdrawals, and investors are reassured. Some have proposed that it's necessary for the federal government to bail out SVB to maintain market confidence.

What dragged the banking index to its lowest level in three years, and prompted a shift to safe havens, is the worry that this is just the tip of the iceberg. The sudden rise in interest rates causes a vulnerability for banks that have low interest paying bonds which they can't sell without incurring substantial losses. That means if a bunch of customers need to withdraw their funds, the bank will have to sell assets at a loss.

SVB is nowhere close to the scale that would make it a "Lehman moment", but the surprise to the market could lead to a revaluation of the stability of the banking sector. How the Silvergate and SVB situation plays out over the coming days could be crucial for whether the market turns more risk averse or not.