American Bank Collapse - Silicon Valley Bank
Two of the largest banks in America have collapsed. California-based Silicon Valley Bank and New York’s Signature Bank, the second largest banking failure in American history. Before this was the collapse of Washington Mutual Bank, the biggest in 2008. Next was the financial crisis in 2008, which influenced the Global recession worldwide. People are scared, that these bank collapses will again result in recession worldwide like 2008? If the American financial system crashes, its impact will be seen worldwide.
What happened exactly?
How did it happen? And What are the impacts worldwide?
Let’s uncover it in this article,
How do banks work?
In layman’s language, banks take money in the form of deposits (Safety for People’s money) and lend the money as loans to their customers (Banks business). The deposit Interest will be less compared to the loan interest banks charge. The second option for banks is investing the money into different plans like stock markets, Govt bonds and the Purchase of Gold. The difference in these interest rates is the profit the banks make.
Example of Silicon Valley Bank:
Established in 1983, Head Quartered in Santa Carla, California. Bank initially invested heavily in real estate businesses. Early 1990s half of the bank’s portfolio was in the real estate business. Experts always speak of diversifying financial portfolios to lessen the risk. You can’t keep all the eggs in a single basket. Invest all your money in Gold and when Gold rates come down all your money is at risk. A similar thing happened with SVB (Silicon Valley Bank), a 50% portfolio in real estate.
1992, the Californian Real Estate market crashed terribly. SVB had to incur a $2.2 Million loss. SVB realized they need to diversify their portfolio so that this doesn’t repeat in future. Since 1992, its portfolio in real estate remained at 10%.
Investments in Tech-Based Startups
A similar thing happened again but on a much larger scale. SVB was known for another major investment between 1995 and 2000. Heavy investments in start-ups. Especially technology-based start-ups. Those tech-based startups are in the venture stage. Providing loans to these new start-ups. The investments were so big that it claimed 65% of America-based startups were invested by SVB.
The customers in the tech industry were the biggest customers for SVB. Technology and Silicon Valley has an unconditional bond. SVB was exclusive as most of the funds were invested in tech-based startups. Banks normally diversify their investments. Till the end of 2022, SVB was the 16th biggest lender in America. Total assets worth $209 Bn.
Why did the bank crash?
Cov 19 p@ndemic, venture capitalists started investing money in tech-based firms. Where everything else was stalled, software-based companies were most successful, as these run through computers and mobiles. 2021, because of this reason tech-based startups raised a lot of money. America raised $330 Bn in total. Almost double the money compared to the previous year.
When tech-based startups had so much of investments, they wanted to deposit the money in banks. SVB was the no1 bank in tech-based startups. March 2021, SVB had a total deposit of $124 Bn from $62 Bn a year before. Almost 100% increase. Such a jump in deposits was not seen in other banks. JP Morgan had a 24% jump.
SVB decided to use this money in making more investments. They decided to purchase govt bonds worth millions of dollars. This wasn’t unusual, banks have their own business models and they invest in different portfolios. Investing in Govt bonds is a much safer move. Not only Govt but money was invested in Corporate bonds as well.
What are bonds?
Corporates and Govt sell bonds and collect money from the public and promise to repay their money with interest after a specified period.
SVB purchased bonds in such a period when interests were very low. As per American Federal Reserve, Interest rates were between 0% to 0.25%. Extremely low, it was expected that the interest rates will remain low but it did not happen. Without getting into too much of technicalities let's understand Bond Prices and Interest rates have an inverse relationship. Low-interest rates will push bond prices up. The longer term you have chosen to invest in bonds, the riskier it becomes. Prices fluctuate and you might make a profit or loss. If bond prices are getting low and you have invested in bonds, you are at a loss.
This was the worst-case scenario for SVB. America increased interest rates, and bonds that were purchased by SVB crashed. SVB suffered a huge loss.
Bank business
The second impact was bigger, for start-ups and companies, taking loans became more expensive. They avoided taking loans. They have invested their money in banks when they had a lot of investments. They started withdrawing their money. Funding from Venture capitalists was not flowing in. SVB was in a problematic situation. Banks don’t keep money in lockers, only a small percentage of money is kept within itself and a lot of money is invested elsewhere. If everyone wants to withdraw money from the bank, banks will not have enough money with them to lend.
A similar situation happened with SVB. Money invested by them was making losses and on the other hand, their customers were trying to withdraw money. Looking at the demand from their customers, they started selling their bonds, selling them at a loss. $21Bn worth of bonds were sold, at a loss of $1.8 Bn. Countering this downgrade was another reason, when it was publically made known that SVB has sold their bonds at such a loss, bank shares fell down. 9th March 2023, the shares of this bank were down by 60%. A day before, Moody’s downgraded the bank’s rating.
The Crash Down
Before anything could be done, avoiding the bank’s crash down was impossible. When people came to know banks doesn’t have enough money and they are selling their bonds at losses people rushed to banks to withdraw their money. Everyone was worried about their money. This is known as Bank Run.
What happened in 2008 was different from what is happening now. There is no fraud detected, it is true that SVB hid a few facts without disclosing them publically. This was a case of bad decision-making; wrong decisions were taken by the people in charge. Time turned out to be unfavourable, and luck did not support it as well.
Why did the Federal Govt reduce the interest rates?
To control inflation, Interest rates and inflation, have an interesting relationship. When there is a slowdown in the country’s economy, the central bank reduces the interest rates. So that people will avail loans and when more loans are availed, people will have more money and when people have more money they spend it on purchasing. This in turn increases the flow of money in the economy, and GDP will move up.
After the P@ndemic interest rates were reduced by govts. On the other hand, when inflation increases, interest rates will increase, loans will be costly, people will not have enough money to spend, and inflation will get controlled.
America and Europe saw an increase in inflation in several months. To control this situation Federal Reserve increased interest rates. This might be the root cause but the bank’s decision-making was also at play. Interest rates will fluctuate but you need to make your portfolio so robust that it is not affected by fluctuations in the markets.
What about money deposited at SVB?
There is a cap on insurance, whatever you deposit money at the bank some of it will be secured by insurance. There is a law created by Govt, in America, the limit is $250.000. It is a big money but looking at the status and image of SVB customers, tech-based startups which had a lot of money deposited, it is said that 89% of the money deposited was uninsured. The response of any govt in such a situation will be similar; the California Dept of Financial Protection and Innovation pounced on SVB. Bank’s receivership was given to FDIC(Federal Deposit Insurance Corporation). Customer deposits worth $175 Bn were used to create a new bank, the National Bank of Santa Clara. The assets of SVB were taken over so that usual business activities are continued. There began a search for a bank that is willing to merge with SVB. Yes, the merger is a solution to protect the interest of depositors. The search is on but President Biden has assured the money deposited is going to be safe, even the uninsured deposits. This also resulted in the stock prices of banks taking a downturn. $100bn worth of money is lost in stock markets by US banks. European banks lost worth $50Bn. Those companies who said their money is invested in SVB also saw an impact on their shares in the stock market. Roku Inc., Y Combinator a start-up accelerator platform and those startups that used Y Combinator also saw a dip in shares.
Conclusion
Startups normally have a single bank account, unlike other major companies. They are very critical of their money because of employee salaries, and operational costs. It is yet to see how big an impact this will make on the American economy and the world economy. Though this is being compared to the 2008 financial crisis, there is a critical difference. 2008 crisis was due to American Housing Market. Banks had lent huge sums in loans such as Housing Loans; people couldn’t afford to repay the loans. The Housing Market crashed. There followed a Global recession. A number of regulations were passed, and laws were created to discourage such incidents. Experts believe the current situation will not be as bad, as SVB customers are largely a specific sector. These startups will surely have an impact but Global Financial Crisis is unlikely.
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