Silicon Valley Bank collapse is the second-largest failure in American history, followed by the Lehman Brothers financial crisis in 2008.
Prolonged easy monetary policies in the US have fuelled technology companies of various scales to participate in the tech boom during the last decade. SVB (Silicon Valley Bank ) also actively participated in raising money to expand its businesses and deploy funds to tech start-ups. However, the escalation of the Russia-Ukraine conflict has raised inflation worldwide (including other factors), and the central banks aggressively adopted a tight monetary policy to curb the same.
Increasing interest rates due to tight monetary policy, the bank’s bond portfolios plummeted. It was a classic bank run on Friday as the Silicon Valley Bank failed to meet the demand for cash of the short-term deposits, whereas they put a significant portion of the same in long-term debt securities.
The regulators of California shut down the bank entirely on 10th March Friday and seized the deposits. It all started on Wednesday when SVB needed to raise nearly $2.25 billion. When the bank failed to raise capital, it sold securities in loss to shore up the balance sheet. Investors reacted to this, and the silicon valley bank stock price fell over 60%. The venture capital firms also advised companies to withdraw their deposits. The banking sector has been deeply hit by the wave of SVB’s failure. Signature Bank of New York has also been shut down on Sunday, registering the third largest fall in the US.
In this article, we will discuss SVB’s collapse and the potential impact on the banking system and investors. But before that, let’s know a little about SVB’s background and business journey.
The history of Silicon Valley Bank
Silicon Valley Bank (SVB) was a specialised financial institution founded in 1983 to help entrepreneurs and innovators in technology and life science by providing them with the resources and support they need to bring their ideas to life. The bank’s headquarter was in Santa Clara, California, and it managed to operate in many countries, including the United States, Europe, and Asia.
The bank’s focus on serving the needs of innovative and fast-growing tech companies has helped it become a leading player in the banking industry. During 1985-1991, the bank was profitable for 21 consecutive quarters. The bank grew along with the progressing tech economy year by year.
From the real estate loan business in the late ’80s to the winery lending business in 1994, SVB experienced both highs and lows in the first decade since their inception.
Then comes the dot-com bubble (1995-2000). During this period, the bank saw tremendous opportunities in computer technology startups and started funding venture-stage companies even if they were not profitable. However, the bubble burst and SVB’s share price fell by 50%. But the bank did not shift its focus from technology companies and continued with its business model to fund innovative tech startups.
According to the Q4 2022 financial report, SVB had $212 in assets, $74B in total loans and $342B in real clients’ funds. The bank was into four core businesses.
- Commercial banking business: to provide financial services to innovators, founders and investors.
- Private banking and wealth advisory: to provide advice, guidance and a suite of solutions to help partners in banking, lending & wealth management.
- Investment banking: primarily to serve technology, life science and healthcare companies.
- Venture Capital Investing: to find investment opportunities in the innovation economy.
The Collapse
From Tech Darling to Collapsing Institution, SVB has seen it all. The 16th-largest bank in the United States collapsed on 10th March due to a bank run.
On 8th March Wednesday, when the bank informed its shareholders that it sold part of its bond portfolio at a steep loss of around $1.8B in need of cash. It created a panicky situation among the investors and depositors. Suddenly the news triggered massive drawing on their deposits. Slowly the bank started running out of cash.
Later on, when the bank could not raise capital to meet the rapid demand for cash, the bloodbath started on wall street, pulling down the share price of SVB by 60% in a single day. Within 48 hours, the 38 years of industry leadership in the innovation economy collapsed.
The Regulators of California had shut down the bank and given control to Federal Deposit Insurance Corporation (FDIC) so that the bank’s assets could be liquidated to pay the creditors and depositors.
Why did Silicon Valley Bank fail?
To understand “why”, we must dive into its annual financial report from 2020-2022 and the US bond market.
After COVID-19, businesses started gaining momentum, and more startups were formed with new innovative ideas. SVB, the market leader in funding venture capital, financed more than 50% of the startups in the US alone. As businesses began to flourish and the companies started parking their money with the bank, huge cash flew into the bank. The demand deposits doubled from $50B in 2020 to $109B in 2022.
With this massive deposit increase, SVB probably did what most other institutions would have done. They invested in HTM (Held to Maturity Securities).
HTMs are generally long-term govt or investment-grade corporate debt (such as bonds). Buyers of these securities intend to hold them till their maturity.
Nevertheless, the investment decision went all wrong for two reasons.
Firstly, SVB drastically increased their investment in HTM securities from $10.7B in 2020 to $88.4B in 2022, not knowing the direction of the interest rate.
Secondly, the bond portfolio underperformed. The portfolio was consistently under loss, with the Fed Reserve bank raising interest rates aggressively now and then to combat inflation.
This is because of the inverse relationship between bond prices and interest rates. The bond value decreases when the interest rate increases. The bank heavily invested in Held to Maturity securities when the interest rate was near zero. The portfolio’s value decreased when the rate increased and has had a substantial unrealised loss since then.
The immediate need for cash forced the bank to sell off their investments at a loss and became insolvent within a few hours on Friday.
Recent updates and developments on Silicon Valley Bank’s story
The new CEO, Tim Mayopoulos, sent a letter to clients on Monday regarding the bank’s collapse. He reassured in the letter that the bank is “open and conducting business as usual.”
This new information brings a shy of relief among the investors and depositors.
During the weekend, the FDIC moved all money and most of the bank’s assets that Silicon Valley Bank owned to a newly formed bank called a ‘bridge bank’. The bank is FDIC- operated with full service to ensure the safety of all the depositors. Customers can still access their money, and new deposits are also safe.
Three takeaways from the letter
- All deposits, including existing and new ones, are protected by the FDIC
- Wire payment transactions held on March 9 and 10 have not been processed and hence stand cancelled
- The bank is conducting business as usual within the US and expects to resume cross-border transactions soon.
The Ripple effect of SVB’s failure on other banks.
SVB’s collapse sows fear among the customers at other banks as well—mainly the clients with deposits exceeding FDIC’s $250,000 deposit insurance limit. The financial sector has felt the ripple effect as it raised concern about possible runs at other banks in the US.
The financial sector has yet again suffered a devastating blow with the fall of not one but two major banks. New York’s Signature Bank was forced to close its doors on Sunday, hot on the heels of Silicon Valley Bank’s catastrophic collapse.
The fall of Signature Bank, a once-$110 billion commercial banking behemoth, is a tragic example of how panic can grip customers and tear down even the most stable financial institutions.
With this fear and lost trust, people will prefer withdrawing cash, lowering the deposits of the banks. With lower deposits, banks will be more cautious about providing loans to small businesses. It will weaken economic activities and diminish money circulation in the market. Thus, it will take a toll on the overall economy, and we will mostly see a recession soon.
What do US officials have to say?
In a speech on Monday, President Biden said that the banking system is safe and Americans can rest assured that their money is secure.
In a joint statement released on Sunday, the FDIC, Federal Reserve, and Department of the Treasury promised to extend their protective umbrella over the deposits of both banks, pledging to provide support and safeguard hard-earned savings.
It’s a bittersweet victory for the depositors, who can now rest assured that their money is safe, but what about the shareholders and the employees who have lost their livelihoods overnight?
The financial meltdown has claimed more victims, and we can only hope that regulators will take swift and decisive action to prevent this from happening again.
In a stunning blow to investors of Silicon Valley Bank, Treasury Secretary Janet Yellen has already ruled out a bailout for the bank. The once-flourishing bank has been abruptly shut down, leaving its stakeholders high and dry.
How big is the impact?
The failure of SVB is different from Lehman’s story. However, in a shocking turn of events, San Francisco’s First Republic Bank has been decimated, losing more than 70% in early trade. And they’re not alone in their misery. Western Alliance Bancorporation plummeted a jaw-dropping 81%, while PacWest Bancorp took a gut-wrenching 50% hit, and Zions Bancorporation sank 27% into the abyss.
It’s a bloodbath out there, folks. Even household names like Charles Schwab, Comerica, and Fifth-Third Bancorp aren’t immune to this financial massacre, with their shares dropping by double digits.
It’s a grim reminder that the financial sector can be unforgiving, and even the most well-known institutions aren’t safe from the merciless ravages of the market. According to a recent study, approximately 190 banks are vulnerable to SVB’s collapse if only 50% of their depositors opt to withdraw their funds.
In the end, the failure of Signature Bank, followed by the Silicon Valley Bank’s collapse, is a stark reminder of how fragile the banking industry can be. As customers continue to look for stability and security in their financial institutions, it’s up to the industry to ensure that trust and confidence in the system are not lost.
Summary
It’s time to face the facts: more banks are collapsing, causing panic. But don’t be fooled by the fear-mongering; these isolated incidents do not indicate a more significant problem with the economy or the banking industry.
Sure, a few banks have gone under, but it’s not because they were issuing risky loans to everyone and their mother, as Lehman Brothers did in 2008.
No, these failures have nothing to do with systemic risks or broader implications. So let’s take a deep breath, calm down, and stop jumping to conclusions. The sky isn’t falling. But we will wait and watch as other parts of the story unfold in the coming days.
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