Can the Silicon Valley Bank Fiasco Cause a Recession?

The Silicon Valley Bank crisis is a significant event within itself. It has caused losses worth billions of dollars. It has also caused the regulators to leapfrog into action in order to prevent a wider contagion in the financial markets and among the banks.

However, many economic experts are afraid that the Silicon Valley Bank is not the end. Instead, it could be the beginning of something much bigger.

Many critics have compared the fall of Silicon Valley Bank with the fall of Bear Sterns in 2008. There are widespread rumors that the Silicon Valley Bank is likely to become a full-blown economic crisis just like the 2008 recession. However, there and many arguments being given against this as well.

Many experts believe that the Silicon Valley Bank fiasco is an isolated incident and is unlikely to cause any impact on the overall economy.

In this article, we will have a look at both these arguments. We will try to understand the logic behind why a recession does or does not seem to be imminent.

Arguments in Favour of a Recession

There are many experts who believe that the banking sector is volatile at this moment. As a result, the effects of the Silicon Valley Bank could spill over and cause a contagion. This could have widespread effects on the overall economy and could even end up causing a recession.

  • More Bank Failures: The most prominent argument is that the Silicon Valley Bank fiasco is not unique. There are several banks that are in a similar situation. The unprecedented rate hikes which are being done by the Fed have created a situation wherein a large number of banks have unrealized losses similar to that of Silicon Valley Bank.

    After the Silicon Valley Bank fiasco, the public has become more aware of the issue. As a result, banks will undergo more scrutiny. The end result could be that the Silicon Valley Bank could lead to contagion even in the Fed intervenes to ensure that all its deposits are paid off when demanded. The Silicon Valley Bank has created a negative sentiment. This negative sentiment can be easily triggered when people realize that the Silicon Valley Bank was not unique and that there are several banks in the system that are facing a similar crisis.

  • Unemployment: The Silicon Valley Bank crisis has the potential to trigger significant unemployment in the overall economy. This is because the Silicon Valley Bank was a prominent lender in the tech sector, cryptocurrency as well as the startup economy. These sectors contribute significantly to job creation in the economy.

    Hence, the fall of Silicon Valley Bank is likely to have a negative impact on the overall unemployment rate. A high unemployment rate has a strong correlation to an economic recession. Hence, many experts believe that the Silicon Valley Bank fiasco can cause inflation.

  • Impact on Credit Creation: One of the negative impacts of the Silicon Valley Bank fiasco on the overall economy is that depositors have become very wary of small banks. These depositors have now started pulling out their money from small banks. The money is then invested either in treasury bills or it is being deposited in larger more secure banks.

    Small banks do not have the deposits against which to make loans and larger banks are becoming more skeptical. As a result, the number of loans being given has gone down drastically. This means that the credit creation process is being negatively impacted. This impact can almost certainly cause an economic recession for the entire community.

Arguments Against a Recession

On the other side, there are many experts who believe that the Silicon Valley Bank fiasco has been the result of poor management within the bank. They believe that the fall of the Silicon Valley Bank cannot spread to other areas of the economy. Some of the arguments mentioned against a recession are as follows:

  • Higher Capital Levels: As compared to 2008, the capital levels held by commercial banks are quite high. Hence, the banking system as a whole is unlikely to collapse. Even if there is widespread turmoil, the higher capital will allow the banks to stay afloat. These high capital levels were created in response to the 2008 fiasco and hence were created to sustain an environment where there is uncertainty about the future of the banking industry.

  • High-Quality Credit: It is important to understand that the 2008 crisis turned into a full-blown recession because at that time the entire banking system was holding mortgage-backed securities. These securities were of poor quality. Hence, when the crisis began their value took a nosedive. This led to the creation of the 2008 crisis. However, when it comes to Silicon Valley Bank, the securities are of high quality.

    Most of the securities have been guaranteed by the government or quasi-government authority. As a result, one can say that their value will not drop so suddenly, and as a result, a repeat of the 2008 fiasco seems unlikely.

  • Less Concentration of Risks: Silicon Valley Bank suffered since it had a large concentration of risks within the same industry. This is not the case with most other banks. The other banks have a wider exposure to different industries. Hence, it is unlikely that all of their depositors will start withdrawing deposits at the same time.

The fact of the matter is that the Silicon Valley Bank is still a small and localized crisis. It has the potential to become something much worse if not managed properly. However, the Fed and other regulators are spending a lot of time and effort in order to ensure that the spread is prevented.

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