Monday, February 26, 2024

The collapse of Silicon Valley Bank and the start of banking crisis

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Around 40 years back, Silicon Valley Bank (SVB) was born in the heart of a region known for its technological prowess and savvy decision-making. The organisation with headquarters in California grew to become the 16th largest bank in the US, catering for the financial needs of technology companies around the world, before a series of ill-fated investment decisions led to its collapse.

What happened to Silicon Valley bank?

As it is the most preferred bank for the tech sector, throughout the pandemic the services were in a lot of demand. The initial market shock of Covid-19 in early 2020 gave way to a shining period for startups and established tech companies, as consumers spent a lot on gadgets and digital services.

Many tech companies used SVB to hold the cash they used for payroll and other business expenses, leading to a stream of deposits. The bank invested a large portion of the deposits, as banks do. Its demise was predicted when it invested heavily in long-dated US government bonds, including those backed by mortgages.

However, bonds have a counter connection with interest rates; when rates rise, bond prices fall. So when the Federal Reserve started to hoist rates rapidly to obstruct inflation, SVB’s bond portfolio started to lose consequential value. If SVB were able to hold those bonds for a number of years until they mature, then it would receive its capital back. But, as economic conditions embittered over the last year, with tech companies affected particularly, many of the bank’s customers started drawing on their deposits. SVB didn’t have enough cash on hand, and so it started selling some of its bonds at steep losses, scaring investors and customers. It took just 48 hours between the time it disclosed that it had sold the assets and its collapse.

SVB’s problems raise from its earlier investment decisions, the run was triggered on 8 March, when it announced a $1.75bn capital raising. It told its investors it needed to plug a hole caused by the sale of its loss-making bond portfolio.

“Suddenly everyone became alarmed that the bank was short of capital”

says Fariborz Moshirian, professor at UNSW and director of the Institute of Global Finance.

Customers were now aware of the deep financial problems at SVB, and started withdrawing money in mass. Unlike a retail bank that serves for business and households, SVB’s clients tended to have much larger accounts. This meant the bank run was hasty. (Adipex) Just two days after it announced it would raise capital, the US$200bn company collapsed, witnessing the largest bank failure in the US since the global financial crisis.

“I recognize the past few days have been an extremely challenging time for our clients and our employees, and we are grateful for the support of the amazing community we serve”

said Mayopoulos, a former CEO of federal mortgage finance firm Fannie Mae who was appointed by the FDIC to run SVB.

Has this resulted in the start of banking Crisis?

Financial futures, which enables investors to theorise on future price movements, rallied for the US technology sector in response to the guarantees. There had been concerns that if that guarantee wasn’t administered, SVB account holders would not have been able to pay employees, sending crease through the economy.

“In terms of stability, they’ve avoided supply chain consequences”

says Moshirian.

Governments and regulators around the world, including in the UK and Australia, are scanning for SVB exposure in their corporate and banking sectors. The longer term questions is whether SVB’s vulnerability to increasing interest rates is to keep case with other banks through an over-exposure to falling bond prices.

While Moshirian says he doesn’t think the banking system is about to unravel, he notes that people initially also felt that the sub-prime mortgage crisis was restrained. That went on to flicker the global financial crisis.

To counter the risk, the Federal Reserve has unveiled a new program that allows banks to borrow funds backed by government securities to meet demands from 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.

There are, however, more immediate concerns for the technology sector. SVB served Silicon Valley, backing startups and other technology companies that traditional banks might inhibited away from. Recently, the sector has been cutting staff as economic conditions deteriorate. 

The effects on interest rates

Almost all central banks around the world have been increasing rates over the past year to subdue high inflation, with the US moving from near zero to more than 4.5% at a swift pace. Most forecasters expect the rates to rise in the US, UK and Australia, before endowing. The appetite to keep raising rates will now be checked if central banks get bothered that SVB’s problems are indicative of a broader weakness in corporate balance sheets caused by the increase in rates.

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