You might have heard that three U.S. banks collapsed in March. You might also be wondering if something like this could happen in Canada.

Headlines like this can be scary. The Silicon Valley Bank (SVB) is the US’s 16th largest. When a bank this big fails, markets tend to be nervous. American government agencies are working to ensure depositors get their money back. But share prices of U.S. regional banks and mid-sized lenders, like the ones that had failed, remain volatile.

Remember that ups and downs in market values – volatility – often happens. It’s best during these times to think about a long-term plan, rather than dwell on this short-term activity.

A classic bank run

In the case of Silicon Valley Bank (SVB), it was a classic bank run that led to its collapse. A bank run happens when most depositors lose confidence and demand their money at the same time. But a typical bank can’t return a majority of its depositors’ money all at once. That’s because SVB lent much of the depositors’ funds to borrowers. Or SVB invested in financial instruments that mature over time.

SVB’s longer-term bond investments were losing value. When some depositors discovered these losses, they demanded their deposits back from the bank. When other depositors followed suit, the bank collapsed, since it couldn’t meet all the withdrawal demands.

What does this all mean for Canada?

Compared to the U.S., Canadian banks aren’t as exposed to risky tech and start-up industries. However, broader borrowing conditions for customers and corporations may freeze in the U.S. That’s because of problems in the banking industry. If that happens, Canada will likely feel the chill too.

Canadian markets fell in the past week because of volatility in the U.S. Our base case does not see the U.S. bank runs turning into a systemic event. That’s primarily because of swift U.S. government actions.

If you’re an investor with exposure to U.S. markets, we encourage you to remain calm.

We do see potential fallout for smaller banks with balance sheet concerns. But few took as much risk as the banks that have so far suffered. Markets have also swiftly priced in these problems.

An isolated incident or a system-wide risk?

Bank failures can be scary and lead to instability. One bank failure can trigger a panic that can bankrupt other perfectly solvent banks. It pays to solve bank runs early. This is why the U.S. Federal Deposit Insurance Corporation (FDIC) acted quickly. It committed to protect both insured and uninsured deposits of the two recently failed banks.

SVB’s collapse is the largest bank failure since 2008. However, its concentrated customer base in the tech industry may not lead to a 2008-style financial crisis.

SVB – the first fatality of higher rates?

Between March 2022 and now, the U.S. Federal Reserve (the Fed) has raised interest rates by over 4.5%. That’s one of the fastest rate hike cycles in U.S. history. It appears that SVB is one of the early casualties of this aggressive tightening. Much of SVB’s long-term bond investments were profitable when interest rates were low. But they lost value with rapidly rising interest rates. SVB’s failure has raised concerns about financial stability. That’s why the Fed has to walk a tight rope between fighting inflation and not damaging the financial system.

Looking forward, the most important signal for the market will come from the Fed later this month. It could signal a less aggressive interest rate move, because of the SVB fallout. In that case, markets will interpret that the era of accelerated rate hikes are likely behind us. What if the Fed continues its aggressive rate hiking policy to fight inflation? Then we expect volatility ahead not just for the U.S., but also for Canada.