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Silicon Valley Bank - The unintended consequences of a high interest rate environment for banks

By Julie Baker | March 22, 2023

The recent collapse of Silicon Valley Bank (SVB) has sent shock waves through the banking community with attention turning to the potential wider repercussions.
Financial, Executive and Professional Risks (FINEX)

The recent collapse of Silicon Valley Bank (SVB) was the second largest bank collapse in U.S. history. This sent shock waves through the banking community with attention turning to the potential wider repercussions of this collapse amidst uncertain global economic conditions.

Of course, banks will never be absolutely secure, since deposit liabilities are supposed to be perfectly safe and liquid, whereas assets are subject to maturity, credit, interest rate and liquidity rates. But the problem at SVB and the cause of its demise was the fact that it was sitting on a massive, unhedged portfolio of long-term government bonds at a time of increasing interest rates. These bonds are supposedly safe, with the Basel regulatory framework assigning a zero rating to them. However, at the end of 2022, SVB had USD $151.6 billion in uninsured domestic deposits against USD $20 billion in insured deposits, and substantial unrealised losses on its bond portfolio as interest rates rose1. These two things together caused many clients to promptly withdraw their money, causing a run on the bank.

In 2022, JP Morgan cautioned clients that these then unrealised losses could wipe out SVB’s entire tier one capital. The impact of unrealised losses on SVB was exceptionally large2.

High interest rate environment

SVB’s collapse was ultimately precipitated by high interest rates as it had been forced to sell long term bonds which had lost value, at discounted rates, prompting alarm and a run on the bank. Indeed, SVB was not the only example of an institution making a one way bet that rates would stay indefinitely low; the UK’s pension crisis last Autumn erupted due to similar assumptions.

Since the financial crisis of 2008, banks have spent their time worrying about the credit and liquidity risks which caused it. Since then, risk management at banks has been strengthened including capital requirements being raised, liquidity rules tightened and stress tests introduced, to provide further comfort to consumers and regulators.

However, there has been little focus on interest rate risk because it has not posed a significant threat for decades. A whole generation of business leaders are operating for the first time in a high interest rate environment and business models have been built on the one way bet assumption that rates were destined to stay permanently low. Of course, all of this changed with the COVID-19 pandemic with central banks unleashing extreme quantitative easing, and then the conflict in Ukraine causing a surge in energy prices.

Whilst the SVB collapse may have caused some respite in rate rises, we cannot assume that this will last and banks remain as vulnerable to runs as ever.

Higher interest rates have caused large unrealised losses in the banking system

Unrealised bank losses on investment securities by year
Graph showing unrealised bank losses on investment securities by year

Source: Silicon valley bank failure

What does all this mean for directors’ & officers’ (D&O) insurers?

Whilst the actions of the U.S. government to guarantee SVB deposits and HSBC’s deal to buy the British arm have eased the immediate concerns, this incident sends worrying signals to the broader D&O market. Confidence in the banking system is shaken – not only has SVB failed, but within one week two other banks have shut down, crypto bank Silvergate and another crypto friendly bank, Signature Bank. In further news, this weekend, UBS agreed to buy Credit Suisse for USD $3.25 billion3 after a frantic weekend of negotiations brokered by Swiss regulators to safeguard the country’s banking system and attempt to prevent a crisis spreading across global markets. An emergency USD $54 billion credit line provided by the Swiss National Bank last Wednesday had failed to arrest a steep decline in the bank’s share price, which had been exacerbated by the wider market turmoil following the SVB collapse.

The potential for a slow rolling crisis has not gone away. Indeed, the wiping out of SFr16b additional tier 1 (AT1) capital bonds in the UBS Credit Suisse deal is causing further concern in the markets. Bank and financial sector shares are under pressure and this is coupled with the dangers posed by unstable economic conditions. Many companies took on huge amounts of debt during the pandemic, and now that government support is withdrawing, businesses look more vulnerable.

The D&O implications of an insolvency are discussed in this WTW article written in 2021 but still as relevant today.

Other considerations to have in mind are:

  • Are program limits adequate?: utilise WTW predictive analytics for a tailored view of your risks and an understanding of expected and more severe loss in a given year
  • Dedicated Side A limits: review dedicated Side A limits and policy wording; close attention should be paid to the protection afforded to directors and officers to mitigate personal liability risks.
  • Regulatory coverage: regulatory coverage is not created equal; consider formal vs informal coverage. Regulators may file litigation against former directors and officers of failed banks.
  • Bankruptcy exclusion: does the policy include a bankruptcy related exclusion?
  • Insured vs. Insured Exclusion: how will the policy respond to claims brought by the regulators in their capacity as receiver against former directors and officers; is there a potential for coverage to be precluded by the Insured vs. Insured exclusion?
  • Definition of insured: does coverage extend to lower levels of management?
  • Reporting provisions: review notice of circumstances and claim reporting provisions to prevent the potential of late notice denials; generally better to give notice sooner rather than later.

All of this turmoil in the banking sector comes at a time when D&O prices are generally continuing to decline amid fierce competition amongst competing insurers, following volatile market conditions in 2019 and 2020. Supply and demand continue to dictate the direction of travel in the market, but Lloyds of London has identified D&O as one of the classes of business it is paying close attention to. For more detail, discuss with your WTW broker.


1 HSBC strikes £1 deal with Silicon Valley Bank UK
2 Silicon Valley Bank failure
3 Credit Suisse sold in cut-price deal to avert banking crisis


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