Why did Silicon Valley Bank fail and is a financial crisis next? | Banks

The collapse of Silicon Valley Bank (SVB) sent shock waves in financial and technological circles.

On Friday, US regulators seized the assets of the Santa Clara, Calif.-based bank after depositors began withdrawing funds en masse amid fears over the lender’s financial health.

Since then, financial regulators around the world have raced to contain the fallout from the SVB collapse, the largest U.S. bank failure since 2008, and bolster confidence in the global financial system.

Why did SVB collapse?

As SVB’s name suggests, the bank’s business was heavily focused on American tech startups. During the COVID-19 pandemic, the lender saw an influx of deposits as tech companies made a roaring trade for people stuck at home.

SVB has invested much of this cash in US government bonds – traditionally one of the safest types of investment.

SVB’s problems began when the US Federal Reserve began raising interest rates last year in response to soaring inflation, causing the value of these bonds to plummet.

As economic conditions in the tech sector have tightened following the pandemic boom, many SVB clients have begun to dip into their funds to stay afloat. Facing a cash crunch, SVB was forced to sell its bonds at big losses, raising concerns about its financial health.

Within 48 hours, frightened depositors had withdrawn enough funds to cause the bank to collapse.

“SVB collapsed because of a stupid rookie mistake in their interest rate risk management: they invested short-term deposits in long-term bonds. When interest rates rose, bond values ​​plummeted, wiping out bank equity,” James Angel, an expert in global financial market regulation at Georgetown University, told Al Jazeera.

“It’s the same phenomenon that wiped out the American savings and loans industry in the 1980s. Some people never learn.

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

“It seems like it was aimed at a particular audience, and we all know technology has taken a hit – and if you’re not diverse, you will too,” Harvey told Al Jazeera.

“Your loan portfolio should be diversified,” added Harvey. “It’s not clear that this bank actually did that.”

What has been the fallout from SVB’s collapse so far?

Two days after SVB’s collapse, US regulators seized the assets of Signature Bank, a New York-based lender known for its dealings with the cryptocurrency industry, marking the third-largest bank failure in history. the United States.

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

The Federal Reserve also unveiled a loan program, the Bank Term Funding Program (BTFP), which aims to build confidence in the financial system by giving banks the ability to borrow directly from the Fed to avoid having to rely on sales of loss-making bonds.

US President Joe Biden sought to assure the public that the situation was under control, saying, “Americans can be confident in the safety of the banking system.”

Nonetheless, bank stocks, including those of the US “big four” – JPMorgan Chase, Bank of America, Wells Fargo and Citibank – fell sharply on fears of contagion in the financial sector.

First Republic Bank, a mid-sized bank based in San Francisco, Calif., saw its share price plunge by up to 60%.

Stocks of banks in Europe and Asia also took a hit.

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

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

How important was SVB to the banking industry?

SVB was the 16th largest bank in the United States and was described as a mid-tier lender rather than a major player.

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

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

By comparison, JPMorgan Chase, the largest bank in the United States, last year had assets worth $3.67 trillion.

SVB, however, had an outsized influence in the tech ecosystem, earning a reputation for backing startups that larger institutions considered too risky to loan out.

SVB’s failure has reportedly left some tech chief executives scrambling to switch banks and explore options for paying staff, fearing they won’t be able to access their funds.

Although deposits from SVB customers were eventually secured, the full effect of the lender’s implosion on the startup scene may not be apparent for some time.

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

While the fallout from the SVB collapse is still being felt, economists generally agree that its failure is markedly different from the implosion of financial institutions, such as Bear Stearns and Lehman Brothers, that precipitated the global financial crisis of 2007-2008.

Unlike institutions like Lehman Brothers, SVB’s activities were concentrated in one industry and had relatively few relationships with other banks.

“The SVB situation certainly has people worried, but I don’t think it’s likely to turn into a Lehman-like situation, especially given how aggressively the Fed has stepped in, including promising to protect even unsecured deposits. insured,” said corporate law professor David Skeel. law at the University of Pennsylvania Law School, Al Jazeera told Al Jazeera.

“I think any direct fallout is likely to become clear fairly quickly, although it’s certainly possible that there are other banks that are in a similar situation due to rising interest rates.”

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

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

“Banks are now required to have a lot more capital than before, which makes them much less risky. Even banks that have made stupid mistakes mostly lose their own money and not that of depositors.”

William T Chittenden, an associate professor of finance and economics at Texas State University, said he believed SVB contagion would be limited.

“With the BTFP, banks will be able to borrow against these securities at their nominal value, which will prevent them from reselling them at a loss. This should give banks the liquidity they need to meet any unexpected demand for cash from their depositors,” Chittenden told Al Jazeera.

“We will find out if it works or if there is widespread fallout from SVB’s failure in the coming days,” he added. “The vast majority of banks in the United States are financially sound and with the new BTFP, depositors should feel comfortable.”

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