Why Did the Silicon Valley Bank Fail and Next Is a Financial Crisis? | banks

The collapse of the Silicon Valley Bank (SVB) has rocked finance and technology circles.

On Friday, US regulators seized the assets of the Santa Clara, California-based bank after depositors began withdrawing en masse, fearing for the financial health of the lender.

Since then, financial regulators around the world have been scrambling to contain the fallout from the collapse of the SVB, the largest bank failure in the US since 2008, and to boost confidence in the global financial system.

Why did the SVB collapse?

As SVB’s name suggests, the bank’s business was heavily focused on US tech startups. During the COVID-19 pandemic, the lender saw deposits surge as tech companies capitalized on providing entertainment and delivery services to people tied to their homes.

The SVB invested much of this cash in US Treasury bonds – traditionally one of the safest forms of investment.

The SVB’s troubles began last year when the US Federal Reserve began raising interest rates in response to rising inflation, causing the value of those bonds to fall.

As economic conditions became increasingly difficult for the tech sector in the wake of the pandemic boom, many of SVB’s clients began to draw on their funds to stay afloat. SVB was short of cash and had to sell its bonds at large losses, raising concerns about its financial health.

Within 48 hours, frightened depositors had withdrawn enough money to cause the bank’s collapse.

“The SVB collapsed with their interest rate risk management because of a silly rookie mistake: they switched short-term deposits into long-term bonds. As interest rates rose, the value of bonds fell, wiping out the bank’s equity,” James Angel, an expert on global financial regulation at Georgetown University, told Al Jazeera.

“This is the same phenomenon that wiped out the US savings and loan industry in the 1980s. Some people never learn.”

Campbell R. Harvey, a professor at Duke University’s Fuqua School of Business, said the SVB’s woes are a lesson in the need for banks to diversify their assets.

“It seems it was aimed at a specific clientele and we all know that technology has taken a hit – and unless you’re diversified, you’re going to take the hit, too,” Harvey told Al Jazeera.

“Your loan book needs to be diversified,” Harvey added. “It’s not obvious that this bank actually did that.”

What are the consequences of the collapse of the SVB so far?

Two days after the SVB collapse, U.S. regulators seized the assets of Signature Bank, a New York-based lender known for its dealings in the cryptocurrency sector, in what is the third largest banking collapse in U.S. history.

To contain the impact, US regulators announced on Sunday that they would guarantee all deposits with both lenders.

The Federal Reserve also unveiled a lending program, the Bank Term Funding Program (BTFP), which aims to boost confidence in the financial system by allowing banks to borrow directly from the Fed to avoid losing money on bond sales to be dependent.

US President Joe Biden has tried to reassure the public that the situation is contained, saying “Americans can have confidence that the banking system is safe.”

Nonetheless, banking stocks, including those of the US “Big Four” – JPMorgan Chase, Bank of America, Wells Fargo and Citibank – have fallen sharply on fears of financial sector contagion.

First Republic Bank, a mid-tier bank based in San Francisco, California, saw its share price plummet by up to 60 percent.

Bank stocks in Europe and Asia have also taken a significant hit.

In the UK, financial authorities announced they had facilitated the sale of SVB’s local unit to HSBC, Europe’s largest bank, to secure £6.7 billion ($8.1 billion) in deposits.

Canadian regulators said they have temporarily taken control of the country’s SVB unit, while Germany’s Financial Supervisory Authority said it has temporarily closed the lender’s local branch.

How important was the SVB for the banking industry?

SVB was the 16th largest bank in the US and was described as a middle-class lender rather than a major player.

“It’s an unusual bank in that it’s not one of the big banks, although it’s sizeable,” Harvey said.

According to the Federal Deposit Insurance Corporation, the lender had assets of $209.0 billion and total deposits of $175.4 billion as of December.

For comparison, JPMorgan Chase, the largest bank in the US, had $3.67 trillion in assets last year.

However, SVB has had an outsized impact on the tech ecosystem. The lender was well-connected among Silicon Valley’s elite and had a reputation for backing startups that larger institutions might deem too risky to lend.

SVB’s failure reportedly led some tech chiefs to scramble to switch banks and explore options for paying employees, fearing they wouldn’t be able to access their funds.

Although SVB customers’ deposits were ultimately guaranteed, the full impact of the lender’s implosion on the startup scene may not be visible for some time.

Could the collapse of the SVB trigger a financial crisis like 2007-2008?

While the aftermath of the SVB’s collapse is still lingering, economists largely agree that its failure differed markedly from the implosion of financial institutions like Bear Stearns and Lehman Brothers that sparked the 2007-2008 global financial crisis.

Unlike institutions like Lehman Brothers, SVB’s business was concentrated in one sector and had relatively little dealings with other banks.

“The SVB situation is definitely worrying people, but I don’t think it’s likely to become a Lehman situation, especially given the Fed’s aggressive intervention, including by promising to protect uninsured deposits as well,” David Skeel , a professor of corporate law at the University of Pennsylvania Law School, said Al Jazeera.

“I think any direct implications will become clear fairly quickly, although it’s entirely possible that there are other banks that are in a similar situation as a result of the interest rate hike.”

Financial regulation has also been significantly tightened since the 2007-2008 crisis.

“Fortunately, after the 2008 crisis, the increased capital requirements seem to be paying off,” Angel said.

“Banks now need to have a lot more capital than before, making them a lot less risky. Even the banks that made silly mistakes mostly lose their own money and not the depositors’.

William T. Chittenden, associate professor of finance and economics at Texas State University, said he believes contagion from SSB will be limited.

“The BTFP allows banks to mortgage these securities at face value, so banks don’t have to sell them at a loss. This should give banks the liquidity they need to meet unexpected cash demands from their depositors,” Chittenden told Al Jazeera.

“We will know in the next few days if this works or if there are far-reaching consequences of the SVB’s failure,” he added. “The vast majority of banks in the US are financially healthy and the new BTFP should make depositors feel comfortable.”

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