The market turmoil caused by the Silicon Valley Bank‘s failure has led to worries that other banks may be experiencing a similar situation. Since the 1980s, SVB has been a significant lender to startups across the US. Last Friday, a massive run on deposits rendered the medium-sized bank unable to survive on its own. Sunday saw the US government announce extensive measures to recover depositors’ funds from the failed SVB. The bank’s collapse is a reminder of the risks involved in investing in startups and the importance of diversifying one’s portfolio. It also highlights the need for stricter regulations to prevent similar situations from happening in the future.
Meanwhile, the bank’s UK arm will is being acquired by HSBC Holdings Plc, the culmination of a frantic weekend where ministers and bankers explored various ways to avert the SVB unit’s collapse. The SVB’s collapse could have had severe consequences for the UK economy, as it would have been the first time since 2008 that a bank of its size failed. The acquisition by HSBC is expected to provide stability and prevent any potential ripple effects.
Why did Silicon Valley Bank collapse in 48 hours?
The short answer is that SVB did not have enough cash to pay their depositors, so the regulators closed the bank. This situation is known as a bank run, where depositors withdraw their funds all at once, causing the bank to become insolvent. The closure of SVB highlights the importance of proper financial management and regulation in the banking industry.
It begins during in the pandemic, when SVB and many other banks were raking in more deposits than they could lend out to borrowers. Deposits at SVB doubled in 2021. But they needed to put all that money to use. As a result, they invested in extremely safe U.S. Treasury securities to cover their shortfall in lending.
The issue is that the value of these securities plummeted as a result of the sharp rise in interest rates in 2022 and 2023. Bonds and other similar securities have the property that when yields or interest rates increase, prices decrease and vice versa.
The bank recently disclosed that the sale of some of those securities cost it US$1.8 billion, and that as their stock started to fall, they were unable to raise capital to cover the loss. This prompted renowned venture capital firms to advise the businesses they invest in to stop doing business with Silicon Valley Bank. Because of this, more and more SVB depositors decided to take their money out. Because of how much money was taken out and how much money was lost on investments, regulators had to close the bank to protect depositors.
What’s next?
According to Ed Moya, senior market analyst at Oanda, while a broader contagion is unlikely, smaller banks that are disproportionately tied to cash-strapped industries like tech and crypto may be in for a rough ride.
“Everyone on Wall Street knew the Fed’s rate-hiking campaign would eventually break something, and right now that something is small banks,” Moya said on Friday.
The FDIC usually sells a failed bank’s assets to other banks and uses the money to pay back depositors whose money was not insured. This means that if small banks fail, their assets will be sold to other banks, and depositors will be paid back with the money from the sale. However, this process may not be enough to prevent a ripple effect on the overall banking system.
