The Ripple Effect of Rising Interest Rates: The Case of Two Small Banks on the West Coast

The recent aggressive campaign by the Federal Reserve to bring down inflation has set the stage for major problems at two California lending institutions — SVB Financial and Silvergate Capital — as an outflow of deposits forced both to sell assets at a loss, mainly bonds. This paper examines the impact of rising interest rates on these two banks and the wider financial market, and explores the reasons why this has occurred.

The Background of the Issue:

Banks are big investors in assets such as Treasury bills because they need safe places to park their cash. Many financial institutions piled into these investments during a period of historically-low interest rates that spanned the early years of the pandemic, as banks took in tons of new deposits and lending was somewhat restrained. However, the Fed is now hiking rates at a rapid clip, with Fed Chair Jay Powell warning earlier this week that the central bank may have to speed up the pace of its rate increases to cool the economy further. The problem that creates for banks is simple: higher rates lower the value of their existing bonds.

The Problems of Two Small Banks:

The withdrawals at SVB’s Silicon Valley Bank have come from startups and technology firms, many of which also ran into new trouble once the Fed began raising rates. The deposit outflow forced SVB to sell assets and take a $1.8 billion loss, a move the bank made “because…