Four decades ago, Silicon Valley Bank (SVB) was born in the heart of a region known for its technological prowess and savvy decision-making.
The California-based organization grew to become the 16th largest bank in the US, serving the financial needs of technology companies around the world, before a series of ill-fated investment decisions led to its collapse. .
What happened to SVB?
As the bank of choice for the technology sector, SVB’s services were in high demand during the pandemic years.
The initial market shock of Covid-19 in early 2020 quickly ushered in a golden period for startups and established tech companies as consumers spent heavily on digital devices and services.
Many tech companies used SVBs to hold cash they used for payroll and other business expenses, prompting an influx of deposits. The bank invested a large part of the deposits, as banks do.
The seeds of his demise were sown when he invested heavily in long-term US government bonds, including mortgage-backed ones. These were, for all intents and purposes, as safe as the houses.
But bonds have an inverse relationship with interest rates; when rates go up, bond prices go down. So when the Federal Reserve began raising rates rapidly to combat inflation, SVB’s bond portfolio began to lose significant value.
If SVB could hold those bonds for several years until maturity, it would receive its principal back. However, as economic conditions have deteriorated over the past year, and technology companies have been hit particularly hard, many of the bank’s clients have started using their deposits.
SVB did not have enough cash on hand, so it started selling some of its bonds at huge losses, scaring investors and clients alike.
Just 48 hours passed between the time he revealed he had sold the assets and his collapse.
What triggered the bank run?
Since banks only keep a portion of their assets in cash, they are susceptible to a surge of demand from customers.
While SVB’s woes stem from its earlier investment decisions, the run was sparked on March 8, when it announced a $1.75 billion capital raising. He told investors he needed to plug a hole caused by the sale of his losing bond portfolio.
“Suddenly everyone was alarmed that the bank was short of capital,” says Fariborz Moshirian, a UNSW professor and director of the Institute for Global Finance.
Clients were now aware of SVB’s deep financial problems and began withdrawing money en masse.
Unlike a retail bank that serves businesses and households, SVB’s clients tended to have much larger accounts. This meant that the bank run was swift.
Two days after announcing it would raise capital, the US$200bn company went bust, marking the biggest US bank failure since the global financial crisis.
Is this the start of a banking crisis?
Immediate concerns of widespread contagion have been contained by the US government’s quick response by guaranteeing all bank customer deposits.
Financial futures, which allow investors to speculate on future price movements, rallied for the US tech sector in response to the assurances.
There were concerns that if that guarantee was not implemented, SVB account holders would not have been able to pay employees, which would have hit the economy.
“In terms of stability, they have avoided supply chain consequences,” Moshirian says.
Governments and regulators around the world, including in the UK and Australia, are testing SVB exposure in their corporate and banking sectors.
The longer-term question is whether SVB’s vulnerability to rising interest rates is similar to that of other banks through an overexposure to falling bond prices.
While Moshirian says he doesn’t think the banking system is about to collapse, he notes that people also initially felt the subprime crisis was contained. That went on to trigger the global financial crisis.
To offset the risk, the Federal Reserve has introduced a new program that allows banks to borrow funds backed by government securities to meet the demands of deposit customers.
This is designed to prevent banks from being forced to sell government bonds, for example, that have been losing value due to rising rates.
However, there are more immediate concerns for the technology sector.
SVB catered to Silicon Valley, backing startups and other technology companies that traditional banks might shy away from.
In recent months, the sector has been cutting staff as economic conditions deteriorate. At a time when they need financial backing, one of their biggest supporters has collapsed.
Did SVB receive a ransom?
The government is not saving SVB; it will remain collapsed, or end up with its remaining assets scattered among creditors, unless a buyer can bring it back to life.
However, on Sunday night US agencies extended a guarantee to cover all deposits at the bank, as well as for clients of a second smaller institution, Signature Bank, which collapsed over the weekend. It means that SVB clients will be able to access all their money on Monday morning.
The bank’s shareholders and some unsecured creditors are not protected by the guarantees.
Will this affect interest rates?
Central banks around the world have been raising rates for the past year to rein in high inflation, with the US going from near zero to over 4.5% at a fast pace.
Most forecasters expect rates to rise in the US, UK and Australia before stabilizing.
Appetite for further rate hikes will now be tested if central banks worry that SVB’s woes are indicative of broader weakness in corporate balance sheets caused by the rate hike.
