Short Take: The Fall of Silicon Valley Bank
Our two cents
In the 1920s, hundreds of banks experienced the “run on the bank” syndrome, which led to stronger regulation and liquidity provisions for banks. Despite these measures, it appears that regulation is still not stringent enough to prevent similar crises. A recent example is the collapse of SVB, a top 20 U.S. bank with approximately $200Bn in assets, which has created a domino effect in other banks.
A “run on the bank” occurs when a large portion or all of a bank’s depositors request their money back simultaneously due to concerns about the bank’s financial health. This can lead to the bank’s inability to meet all customer requests, and ultimately, its collapse if there is no government intervention.
Before discussing the factors that led to SVB’s insolvency, it is essential to understand two concepts:
- Banks are for-profit entities that aim to generate returns on their liabilities, including customer deposits. They do this by investing depositors’ money in long and short-duration securities to earn a spread (i.e., percentage difference or profit) on what they owe to depositors.
- The complete shutdown of the world economy during the COVID-19 pandemic led to years of loose monetary policy, with low-interest rates and an abundance of cash in the markets. This eventually forced inflation to rise, prompting central banks to increase interest rates to control inflation.
SVB faced two major issues:
As interest rates increased, venture capital investments slowed down, leading to reduced funding for startups and consequently, fewer deposits in the bank. Startups, however, did not taper their spending in response to the economic climate, further depleting SVB’s deposits.
During the COVID-19 pandemic, when SVB was flush with deposits, the bank invested in 10-year mortgage-backed securities (or “available for sale” securities). Back then, interest rates were at 2%. However, when interest rates rose to 5%, the value of these securities dropped by 25%.
To visualize this, assume a $100 face value bond earns 2%. It is held for 10 years and yields around $122. Whereas this same $100 face value bond that earns 5% and is held for 10 years yields around $163. This means that the initial bonds decreased by 25%
Such factors forced SVB to liquidate its securities at a discount and attempt to fundraise more money. The news of the bank’s struggle quickly spread throughout Silicon Valley, causing startups to rush to the bank to withdraw their deposits before it was too late. The collapse of such a large bank has created a significant ripple effect on other banks, especially those with investments or deposits in SVB or other regional banks, many of whom were also suffering from the same issues.
In conclusion, the fall of SVB and that of other banks highlights the need for stricter regulations and better risk management practices in the banking industry to prevent similar crises from reoccurring in the future.