The remarkable speed with which Silicon Valley Bank failed has investors concerned that this may signal the beginning of a widespread banking crisis. The Federal Government of the United States has attempted to minimize the harm. It has already insured customer deposits, yet the global financial markets continue to feel the effects of SVB’s demise.
The U.S. government has also taken the step to close down a regional bank, known as Signature Bank, which was also close to the brink of collapse, and has guaranteed deposits for the bank. It should be noted that officials are taking the failure of SVB seriously, and the U.S. President, Joe Biden, claimed that there isn’t any need to panic because the banking system is entirely secure.
However, if you want the complete low-down on what happened and what caused one of the biggest banking failures in the US since 2008’s global financial crisis, you’ve come to the right place. We will be sharing all the details with you down below.
The Silicon Valley Bank
The Silicon Valley Bank was established in 1983, and before its collapse was the 16th largest commercial bank in America. It used to offer banking services to almost half of all the US venture-backed technologies and life science companies. The bank also operated in the United Kingdom, Canada, Sweden, Israel, Ireland, Germany, Denmark, and China.
In recent years, the explosive growth of the tech sector greatly benefited SVB, which was fueled further by the boom in demand for digital services induced by the pandemic and borrowing costs that were ultra-low. According to financial statements, the bank’s assets included loans and had tripled at the end of 2019 from $71 billion to its peak at $220 billion by March 2022.
Over that same period, the deposits had ballooned to a staggering $198 billion from $62 billion, mainly because tech startups numbering in the thousands started parking their cash at the lender, which led to a doubling of its headcount globally.
The collapse of Silicon Valley Bank was sudden, followed by 48 hours of frenzied activity where customers started yanking deposits from the lender, which was deemed a classic run on the bank. However, the root cause of the demise goes several years back. Like most other banks, Silicon Valley Bank had ploughed billions of dollars into US government bonds, especially in the era of interest rates that were near zero.
What seemed like a safe bet to everyone quickly unraveled in front of everyone’s eyes, mainly because the Federal Reserve had to tame inflation and aggressively hiked interest rates. Bond prices fall when interest rates rise, so the jump in the interest rates eroded nearly all the value of the bond portfolio that Silicon Valley Bank had held.
According to Reuters, the portfolio had yielded 1.79% on average in the past week, which was well below the 3.9% 10-year Treasury yield. Meanwhile, happening simultaneously was the hiking spree of the Feds, which had sent borrowing costs to higher levels, and that meant more cash had to be channeled by tech startups to repay the debt. The bank was also already struggling to raise new venture capital funding.
All that had forced businesses to draw down their deposits held by Silicon Valley Bank for funding their growth and operations.
What Sparked the Bank Run?
Even though most of the problems being faced by SVB could be traced easily to the investment decisions they had made earlier, the run on the bank had been triggered when the lender announced that it had to sell a lot of securities at losses and will be selling $2.25 billion in newer shares for plugging the holes in their finances.
This ended up panicking their customers, who started to withdraw their money in unprecedented amounts. That caused the bank’s stock to drop by 60% and also dragged other bank shares down as investors started to fear that the global financial crisis, which happened more than a decade ago, would be repeated.
Soon enough SVB shares trading was stopped and the bank abandoned all its efforts to raise capital or find buyers. That was when California regulators intervened to shut the bank down and placed it in receivership in the Federal Deposit Insurance Corporation, which meant that the bank’s assets were liquidated so that creditors and depositors could be paid back.
The Trigger to Another Banking Panic?
The signs don’t look good, as a couple of other banks are already feeling the heat and under stress. Trading was halted temporarily in PacWest Bancorp (PACW) and First Republic Bank (FRB) after their shares dropped by an astonishing 52% and 65%, respectively.
The situation in Europe wasn’t much different as the Benchmark Stoxx Europe 600 Banks index that tracks all the biggest 42 banks in UK and EU fell by 5.6% in trading in the morning, which had been its biggest fall since March of last year. Also, shares in Credit Suisse, the embattled Swiss banking giant, had fallen down by 9% as well.
To compound matters, you only have to look at the fact that the investments SVB made into government bonds and other assets fell dramatically in value, and other financial institutions are in the same boat. When you look at other US banks, by the end of 2022, they had been sitting on unrealized losses that totaled $620 billion, which according to the FDIC, are assets whose price has decreased, but they have yet to be sold in the market.
In what could be taken as a sign by regulators about an extended period of financial chaos in the banking sector, the Fed claimed that it would make additional funding available to all eligible financial institutions to ensure that the next SVB doesn’t collapse.
Most analysts have already pointed to the fact that European and US banks have got stronger financial buffers today compared to when the global financial crisis occurred in 2008. They have also highlighted that SVB had extremely strong exposure and ties to the tech sector and has been hit the hardest by the ever-increasing interest rates.
Trump Administration’s Unguided Attack on Banking Regulation
It shouldn’t be mistaken that the Silicon Valley Bank was the second largest bank to collapse in the history of the United States and has been the largest since the Great Recession. There were a number of reasons why that happened, which included an over-reliance on the tech-startup industry and poor risk management.
Nonetheless, many legislators have blamed Trump’s easing of banking rules as the primary cause of the problem.
These banking failures could have been avoided entirely if the Fed and Congress had done their jobs and ensured that strong banking regulations had been in place. Dodd-Frank was signed into law by President Obama in 2010 in response to the 2008 financial crisis. It included extensive reforms to strengthen regulation of the financial sector, defend consumers, and prevent further economic downturns.
However, Trump rolled back the legislation’s key provisions in 2018 and claimed that the Dodd-Frank regulations had crippled small businesses and American workers. The Republicans had led the rollback, but they had also been joined by conservative and moderate Democrats. Trump had claimed it was a truly great day for banking at the time.
Fast-forward five years later and the consequences of an extremely lax regulatory attitude for banks like SVB have become clearer. Had the Federal Reserve and Congress not rolled back the strict oversight, then both SVB and Signature wouldn’t have been in this position.
Oversight in Canada and Ireland
Historically, Canada’s highly regulated banking sector has helped it weather economic storms. However, the lending procedures of the country’s largest banks are generally conservative, which lessens the likelihood of a systemic collapse. Additionally, the Canadian government maintains a scheme that protects depositors in the event of a bank failure.
Similarly, Ireland’s financial system is well-regulated and supervised by the Central Bank of Ireland. During the 2008 financial crisis, the Irish government has taken steps to restore the stability of its banking system, including the development of a plan that guarantees deposits up to a specific limit.
While no financial system is fully immune to failure, the regulatory and supervision systems in place in Canada and Ireland reduce the likelihood of a comparable failure to SVB.
The Silicon Valley Bank collapse is a lesson that current U.S. regulations and policies are still lax and the government is playing catch-up to rectify the problem. President Biden has vowed to resolve this issue and not let it spiral into a full-blown meltdown like the global recession in 2008 and it remains to be seen what policies are going to be implemented in the system.