The Decibel - What Silicon Valley Bank’s collapse means for Canada

Episode Date: March 16, 2023

The collapse of Silicon Valley Bank came swiftly after a panicked run on deposits. Despite the U.S. government enacting safeguards, there is anxiety in the markets wondering which bank might fall next.But how safe are Canadian banks? Report on Business columnist Tim Kiladze is on the show to explain the fallout and what Canadian regulations are in place to try and contain it.Questions? Comments? Ideas? Email us at [e-mail]

Think about everything you've been told or learned about what to do when a building's on fire. It's all about exiting calmly, orderly, and as long as everybody does so in that fashion, things should be fine. Everybody will escape. The problem is, somebody panics. That's Report on Business columnist, Tim Collatz. Somebody starts running, and as soon as somebody starts running, other people start running, and you have a stampede. People get trampled on, and maybe not everybody makes it out.

Chaos ensues. The banking system is quite similar. This metaphorical fire happened at Silicon Valley Bank, which collapsed last week. It's a bank that mostly invested in the tech sector. Think startups. And its downfall is the largest bank failure since the 2008 financial crisis. You know, if everybody starts running for the doors, it makes other people want to run because nobody wants to be the last person standing. This bank run has sent panic across the economy as investors worry about which bank might fall next. And here, the question is, how ready are Canadian banks to handle this panic? And is our money safe?

At the end of the day, it sounds so philosophical, but the banking system is based on trust. I'm Maina Karaman-Wilms, and this is The Decibel from The Globe and Mail. Tim, thanks so much for joining me. I want to say great to be here, but this time it's under shakier circumstances, globally speaking. Indeed, yes. Yeah, well, this is good. This is why we're talking to you today, of course, to help understand what's going on. So I thought we could start off by just getting a sense really of what happened to cause people who banked with Silicon Valley Bank to pull all of their money out at the same time last week. It actually goes back about three months.

And Silicon Valley Bank publicly reports earnings. So the information was there. It's just that no one was really paying attention. So the bank has kind of been reporting that it had cash outflows. It funds startups. Startups have been hurting for cash because it's just been a tough environment for technology companies. I think that part's pretty simple to understand. But because there were so many cash outflows, it had to kind of come up with a shortfall or find a way to make sure that there was a buffer so that it wasn't just running out of cash, the bank itself.

So it has all of these bonds that it had invested in. The bank was so flush with cash during the pandemic because so many startups, so many tech companies had money, right? That's kind of been the story of the pandemic or was the story. Because the bank had so much cash, it was like, well, we don't want to just sit here and earn nothing on it. So we're going to invest it in bonds. And in some ways, it was like, well, we don't want to just sit here and earn nothing on it. So we're going to invest it in bonds. And in some ways it did the right thing. It put them in very safe securities, US government bonds. These things are not by any means risky stuff normally.

And that's normal for a bank to invest people's deposits like that? Yeah, very much so. Most people don't see kind of the back end to banks, but at the end of the day, banks are really about funding and liquidity. That's kind of a term within the sector. And it basically means, what do you do with all the funds you have available and how do you loan them out?

And liquidity meaning, how quickly can you access that money when you need to? And this has been a real example of just how that can go wrong if you don't structure things the right way. It's probably the best way to put it. So it's weird because it had all this money in bonds that are safe bonds. But what had happened over the last year or so was that the bond market, like the stock market, took a big hit because of interest rates. Rates rose, which means bond prices fall. I know that can kind of mess with your mind a little bit, but it's just a fact of life.

It's just how it works. And it normally wouldn't be a problem because they're holding these bonds until the bonds get paid back normally. So it doesn't matter what kind of the daily market moves are because bonds are kind of a fixed contract. But because they had these cash outflows, they had to all of a sudden sell some of these bonds to make up the shortfall. So they needed money, essentially.

Exactly. And some of that was not because they were actually in dire straits of running out of money, but there's all these rules and regulations in place that make you say you have to have X amount of money available as a buffer, basically. And so it was all very public. They talked about how they were selling these things and that kind of made everybody pay attention. And it was like, wait, what? You know, you're selling these things at a loss. Like that's not a good thing. And if they're selling them at a loss, it must mean that they're in trouble. One of the big developments that also sparked more fear was

that the debt from the bank, the bank itself basically got downgraded by one of the rating agencies. And I think one thing that cannot be said enough in this crisis or whatever you want to call it is Silicon Valley Bank is kind of in the zeitgeist right now in the sense that it's a tech bank. It funds a lot of startups. Startups are hurting. You know, it was kind of this perfect storm. I know that term gets overused, but it really and truly was. Okay. So what we just talked about, that explains how things got shaky at the bank itself. But then the next stage is when people panic. But I guess the question is, how do clients know that other clients are pulling their money out of the bank, Tim?

What happened here is that Silicon Valley Bank wasn't really like a retail bank for me and you. It's a bank for companies. And every bank has, they're called commercial banking arms. Every bank does this, but Silicon Valley was almost exclusively a commercial bank. And so when deposits started to move or like when a client wants to pull funds, they're pulling like millions of dollars. Whereas an individual client, if they start to run, they might just pull, I don't know, 10 grand. Large clients will pull 100 grand, whatever the case may be. But these are really chunky deposits is the term that gets used. And because they were all

startups and a lot of them are in Silicon Valley, they were all talking that gets used. And because they were all startups and a lot of them are in Silicon Valley, they were all talking to each other. And so there's been multiple stories now about how there was group chats set up on WhatsApp or whatever, where like a hundred people would be in a chat and they'd all start talking about what are we going to do? What are you doing? In those situations, it makes fear spread way more quickly because, you know, it's not one to one communication. It's one to 100. So this is like the fire metaphor that you're talking about, right? One person panics, everyone around them starts to panic.

And this is what happens. So you're saying if this, I guess, if this kind of contagion didn't happen like this way, the bank might not have collapsed the way it did? Totally. And one thing that has become clear in this, and then I think regulators are going to have to learn to address, is that in the age of not just social media, but in the age of electronic everything, as a way to put it, you can move money really quickly. You know, even in the last financial crisis in 2007, 2008, there were pictures of banks failing, particularly in the UK, and people kind of lined up outside the bank to go inside to the branch and get their deposits out. Now you can just do that with like a few clicks, you know, you can move money in a matter of hours. And you couple that with the, sometimes it's not even fear. It's just, well, I'd rather be safe. So I'm going to move my money just in case, because you don't want to be the last idiot standing that mentality, you know, it can cascade really, really quickly.

Yeah. Okay. So, so I can, I can understand how this situation played out at Silicon Valley Bank, but, but this is just a regional bank from California that mainly deals with the tech sector, as you said. So it sounds bad for its clients, but it's, we're also worried about this kind of on a bigger scale. Why is this a cause for concern beyond that? There's no way of knowing just yet whether other regional banks will face the same problem. There have already been reports about how in the U.S. regional bank clients are leaving their local bank for the likes of a J.P. Morgan or Bank of America, which is just a bigger, broader bank that has no chance of failing.

They're literally too big to fail. It's the classic line. So if that keeps happening, you're going to see more banks fail. And connecting that to the broader economy, it just means that you're going to have less banks willing to underwrite loans and give out mortgages.

And then that can make economic growth stall. A lot of original banks saw their share prices suffer in the past few days. But stock market investors are kind of stupid at times, to be honest. They panic too, right? And so they're not the best gauge in the moment of where things stand. The US government put in new measures over the weekend that were actually quite remarkable in the sense that they came up with them in a matter of days. And they kind of really quickly dusted off a playbook that they've been putting together for years of how to respond to the next banking crisis. And they were swift. Will it work? It's going to take time to figure that out. But what they've effectively tried to do in the simplest terms is say,

no one needs to worry about the value of bonds at any bank's portfolio. Consider that cash because we'll buy the bonds and we'll just hold them until they pay back. So the situation that Silicon Valley Bank got into where they had to sell those bonds at a loss, nobody else is going to have to face that. Exactly. But couldn't there be an unintended consequence here too? Some people really do worry about that. To me, I actually, I personally viewed it as a very smart compromise where it was like, we're going to let the bank fail. All the shareholders in the bank

have lost all their money in their position or investment. So there was a real failure here. Like none of those people got bailed out. The people who got quote unquote bailed out, if you really want to use that term, are the depositors, the companies that stored their cash there who literally did nothing wrong. Like they were just, they used the bank. There had been no like, there had been no loan losses on the portfolio or horrible ones lately.

Everything was functioning. It just goes back to this was a funding and liquidity issue that the portfolio or horrible ones lately. Everything was functioning. It just goes back to this was a funding and liquidity issue that the bank just truly messed up. And so the government isn't, so far at least, saying we're going to support all banks, crappy ones, great ones, and whatever. They're just saying if you're a client of a bank, you shouldn't have to worry as much. And they're hoping that that instills some confidence in the system. Okay. And this is the, I guess we should just point out in the US, the banking system is a little different than Canada.

Canada, we have the big six. These are big, massive banks, but there's a lot of smaller regional banks in the States then. And this is why we're talking about these little banks that I know a lot of people probably haven't even heard of here. Yeah. It's a very different environment. And also banks fail in the US all the time.

Maybe that's overstating it, but it's a common thing because there are so many smaller banks. But then on top of that, because it was Silicon Valley Bank and you had these big venture capitalists who are big in Silicon Valley, they were literally out on Twitter

just like screaming about how you need to save us. You need to save the bank. You're killing our community. Wow. It created its own fear, not even about the bank itself. It was like, you're going to kill our entire sector, which was certainly an overreaction. And don't get me wrong. I think that there's going to be a lot more pain to come.

And every little hiccup is going to get put under a magnifying glass. European bank Credit Suisse needs more cash. It's already saying it's struggling to get that. So everyone's like, oh, my God, this is the next domino to fall. And perhaps it is in a way. But nobody realizes that Credit Suisse has been in trouble for like years. Like its stock prices has crumbled for various reasons. Like it's just been a really badly run bank.

But in a crisis, no one thinks about or knows about or most people don't know about that history, right? They're just like, oh my God, another one's going. Get out. We'll be right back. Let's get into, I guess, the bit of the, as Canadians, what we need to be thinking about here. Because Silicon Valley Bank, it does have a Canadian arm. When we're talking about this panic and contagion, could it be spreading beyond the U.S. banking system?

Like, could Canadians be affected by this? Well, to start with Silicon Valley Bank in Canada, they're a pretty small operation. And the key thing here is that they actually had no deposits here. It really here was just a lender. It made loans to Canadian companies. So it's very much seen as a limited impact. The fear, of course, is that, yes, it does spread to a broader banking sector in Canada and across the world. I keep stressing that Canada has seen a number of what we call stress tests over the last 15 years. I mean, it's been quite remarkable.

We had the global financial crisis. We had a European debt crisis. We had an energy crisis in 2014 when oil prices crashed really, really quickly. We had the pandemic. There have been multiple instances where things could have really gone wrong and Canada really withstood all the pain. Canada's banks have long been held up as kind of global standards for being financially sound and being risk averse, all that kind of stuff,

the stuff that you'd actually want to see. And there's always been this weird Canadian trade-off where, you know, we get mad at the banks, the fees are too high, they screw us over on certain things, like all of which is true. But they charge high fees because they have high capital requirements, basically cash cushions that the regulators make them store. More protection, essentially. More protection, exactly.

So when things go bad, we don't have to worry as much. And that's playing out again so far. And so it's kind of always been this Canadian compromise. That being said, you cannot underestimate the impact that global fears put onto the whole sector. Okay. Are there any other points of connection, I guess, though? Like, are Canadian banks involved in the American banking sector at all? Yeah.

So there's a number of them that actually have been trying to expand in the U.S. RBC, TD is probably the biggest player in the U.S. TD actually has a retail bank in the US. A rather big one too. BMO, CIBC. So there are definitely kind of one-off situations. I'll give you a perfect example. TD is currently in the process of trying to buy or has a deal to buy First Horizon, which is based in Tennessee. That was inked about a year ago. TV's agreed to pay $25 per share. First Horizon, just before I came in here,

was trading around $16 per share. Now the deal, everyone kind of thinks the deal is going to either get renegotiated or TV's going to walk away and say, why would I pay however much more percent than I need to? So there's real exposure, but it kind of goes back to the same thinking around JP Morgan and these major heavyweights. The Canadian banks have other big bases or a

broader base that they can kind of rely on. So wealth management's often held up as one of the more stable businesses because, you know, if you have money in TD funds, you know, they're still earning that percentage for managing your money every single quarter. And that's profit for them that they can use to help subsidize any losses that might arise from bad loans or things of that sort. So they've got a bigger tank is what it boils down to. Whereas a lot of these community banks in the US, they're literally just your plain vanilla kind of retail bank with some loans out to local businesses. Okay. Okay. So I mean, it does sound like the Canadian system we've

got is a little bit more stable, more diversified, as you said, Tim. But I guess I come back to the idea of the panic itself, right? Like what's happening in the States right now? I just you think maybe it could have an impact on Canadian banks. Like if people decide to pull their money out of banks because they're not confident, they don't feel like it's a good place to keep their money. I guess what I'm wondering is like could a bank run happen here as well? A bank run could happen anywhere at the end of the day it sounds so philosophical but the banking system is based on trust because no bank anywhere in the world uh has enough cash to fund all of their deposits in the system there's

actually like the rules actually state you only have to hold a fraction amount, a fraction of your deposits on any given day to fund withdrawals. So if everybody everywhere went to their bank to take money out, you would just freeze the system and they'd be like,

no one can get their money back right now. But it's it's based upon um trust that people won't do that and that people trust their banks we talked a little bit about u.s regulations and what's in place to kind of try to stabilize things a bit but what about canadian regulations tim like what's what's actually in place here in this country to keep banks stable and make sure the system's okay? One of the big things that has come to light in the U.S. and is also relevant in Canada is that we have deposit insurance. So it's mostly applicable to retail people, me and you, and any individual person. And you get $100,000 of coverage.

It's from CDdic canada deposit insurance corp kind of bulky name but your money is mostly i don't say mostly safe your money is safe um because so if you have underneath a hundred under a hundred thousand dollars in the bank you'll you'll that's safe you'll get that back essentially if something goes under the government effectively backs it and also the banks pay in the same way that you and I pay insurance for our car or for our house or whatever, like the banks have actually paid an insurance premium so that they get the safeguard against their deposits. So the money is safe.

Another thing I would stress is that Canada's banks truly are held up as a global standard. And largely it's because we've been ahead of the curve in many ways about where regulations needed to go. So in 2008, one of the big reasons why we didn't get into a lot of trouble here in Canada is because we forced the banks to have a bigger cushion. It's what it boils down to, a bigger cash cushion, capital cushion, whatever you want to call it. And we've only enhanced that over the past 15 years. So the banks are well governed, like I really and truly mean that. And another big difference is, in the US, whenever you have a banking system change proposed, there's a huge fight that goes on all these lobbyists are hired to lobby the government and lawmakers you know senators and things of that sort to try to prevent something from being passed here in canada some people hate it because

everything's kind of done quietly behind closed doors and it's seen as kind of it can be seen as almost being done in secret but it also works know, whenever some new big rule is announced, you don't have this huge fight. And even if people really disagree with it, they really kind of try to debate it out behind the scenes. And don't get me wrong, we get some things wrong. Like, I'm not saying that things are perfect. But again, it's kind of the Canadian way in the sense of we like order and we like stability. So what it sounds like you're saying, Tim, is there's essentially different risk tolerances here.

Like in Canada, we tolerate less risk in our banking system. So I guess with that in mind, I'm wondering what banking regulators are doing this week in response to the collapse of Silicon Valley Bank. Like what's in place here to keep things stable? Yeah, for now, because things are already so safe or there's such stability, there's nothing drastic, which is a good thing. You know, it means that no one's panicking. But what the banking regulator is doing is just asking the banks to send

essentially daily updates about their cash positions, their liquidity, their deposits, so that we get quick intel on whether or not a bank run is developing. So they want to get ahead of that if that is the case. But again, it doesn't mean that they're doing it because they're seeing signs of stress. It just means we want to be on top of this so that unlike Silicon Valley Bank, where all of a sudden all these things happened and now we were playing catch up, they can get ahead of it this time if something were to materialize. Okay. Tim, this was really interesting.

Thank you so much for being here today. Always happy to. Before you go, The Globe wants to hear from you about how the pandemic has shifted your priorities. We want to hear about the about how the pandemic has shifted your priorities. We want to hear about the big and the small changes you've made. So send us an email at audience at globeandmail.com. That's audience at globeandmail.com. That's it for today.

I'm Mainika Raman-Welms. Our producers are Madeline White, Cheryl Sutherland, and Rachel Levy-McLaughlin. David Crosby edits the show. Adrian Chung is our senior producer, and Angela Pachenza is our executive editor. Thanks so much for listening, and I'll talk to you tomorrow.