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Why The Silicon Valley Bank (SVB) Collapse Feels More Problematic Than The Last Banking Crisis – The Global Financial Crisis

A good old bank run brought down one of the largest US banks.

Silicon Valley Bank (SVB)

By now, anyone keeping up with financial content would have read about the failure of Silicon Valley Bank (SVB), as well as that of Signature Bank and the financial troubles of Credit Suisse.

While not many of us in Singapore may have heard of Silicon Valley Bank, it is not some recent start-up. Far from it in fact. Before its spectacular collapse, SVB was a 40-year-old bank prominent within the tech start-up space. It was the 16th largest US bank, held deposits topping US$200 billion and had a market capitalisation of close to US$16 billion.

However, within a 48-hour timeframe, it all fell to zero. While incredibly troubling news on its own, SVB’s collapse feels more “problematic” than the last banking crisis in 2008 – the Global Financial Crisis (GFC).

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Subprime Loans Feel Like A Financial Product Always Destined For Trouble

We have the benefit of hindsight in saying this. But, the catalyst for the GFC was excessive risk-taking in subprime loans – something that still feels like it was always headed towards a day of reckoning.

Leading up to the GFC, individuals with poor credit ratings were encouraged to take on home loans, at higher interest rates to account for their higher risk profile. As a result, the housing market continued growing into a bubble.

Financial institutions offloaded these subprime home loans to investors in the form of high-yielding mortgage-backed securities (MBS) or collateralised debt. On top of this, investors in these assets could leverage up their initial investments – taking on even more risk.

When a downturn in the US housing market hit, subprime borrowers were often unable to repay their mortgages.

In some ways, this is less “problematic” than the current collapse of Silicon Valley Bank because of the inherent greed, excessive risk-taking and creative financial engineering that went on.

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SVB’s Management Team Invested In Long-Term Government Securities

While the full information on the collapse of SVB is not out. From what material we have read, it feels like the management team at SVB was not coming up with creative financial products to increase its business nor package away to unsuspecting investors.

Banks earn an interest spread. They pay out lower interest rates to depositors and charge higher interest rates to those who want to borrow money. Apart from lending out money, banks also invest.

SVB had to do something with their increasing deposits, which grew from US$17 billion in 2011 to US$189 billion in 2021 – growing faster than any other bank in the S&P500. They was trying to earn a higher return by investing in longer-dated US government securities, including bonds and mortgage-backed securities.

When interest rates started to rise, the value of their investments fell.

Interest rates didn’t just rise though. The US Fed increased interest rates from near-zero levels to about 4.5 to 4.75% in under a year.

Did SVB take on higher risk than it should have? Probably. But it will be hard to argue that its managers were greedy or misguided. It wanted to earn a higher return. But, far from getting mired in shady financial products, they were invested in relatively safe US government securities.

Existing FDIC Deposit Insurance Was Not Enough Protection To Prevent SVB’s Downfall

As far as bank collapses go, the demise of SVB is right up there with the worst. It’s the second largest US bank collapse – behind Washington Mutual in 2008.

What brought SVB down was a good old bank run. A bank run happens when depositors rush to withdraw their savings in a bank. However, since banks lend out and invest a large portion of deposits they get, no bank will ever be able to make good on withdrawals anywhere close to the amount of deposits they take in, especially in a short space of time.

As a result of increasing interest rates, SVB faced even higher withdrawals from start-ups. Running low on liquidity, SVB had to liquidate their positions in longer-dated US government securities at a loss.

On 8 March 2023, they announced this loss. News of SVB’s plans to raise US$2.25 billion through a sale of common and preferred stock broke at almost the same time. To add insult to injury, Moody’s also downgraded SVB’s issuer rating.

Spooked, SVB’s shares crashed when markets re-opened, while customers rushed to withdraw their deposits, on 9 March.

By 10 March, regulators announced they would take over the bank. They also promised to back-stop all deposits by every bank to contain the situation. This effectively put a stop to any risk of bank runs contagion.

In the US, the Federal Deposit Insurance Company (FDIC) insures up to US$250,000 per depositor per bank account. However, many of SVB’s clients had more than US$250,000 in their accounts – and would not be fully compensated. They were also start-ups – typically reliant on funds to continue operations. Unfortunately for SVB, a barrage of bad news instigated a bank run.

While not in a great position, SVB may have very likely been able to continue operations had their fundraising gone through.

Separately, if they hadn’t been the first bank to become a target of a bank run, they would have enjoyed additional protection from the FDIC for all uninsured funds. Their clients would have been unlikely to rush to pull out their cash from the bank. Again, it’s hard to see them failing if the FDIC protection was adequate in the first place, or if they had simply not been the first bank to succumb.

This is unlike what happened in the GFC, where it was clear that there were loopholes being exploited, and multiple facets to the financial engineering. No amount of support would have been able to save the situation.

This is also why SVB’s failure is more “problematic” as the lessons to heed are few and that SVB could have survived given the same economic environment but more efficient fundraisers to help sell its common and preferred stocks (which would have beefed up capital) and better timing on its credit rating downgrade.

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