As of March 10, 2023, Silicon Valley Bank (SVB) experienced a bank run and subsequently failed, making it the second-largest bank failure in the history of the United States and the largest one since the 2008 financial crisis. SVB, which held over $200 billion, was one of two banks to fail in the United States during the month of March 2023. The bank was the epicenter of Tech, Startups, and venture capital. So what really happened to the mighty SVB, and why has it fallen?
How Do Banks Operate?
In order to fully grasp the importance of SVB, it is crucial to have an understanding of the banking system and its inner workings. Banks operate as financial institutions where we place our money with the expectation of accessing it later. However, what is frequently overlooked is that depositing money in a bank means engaging in a variety of financial activities that have the potential to yield substantial long-term profits.
Banking is an Investment
For example, if you were to deposit $10,000, the bank would keep 10% and invest the remaining 90% in government bonds or other securities. The money multiplier effect, as it’s called, enables the bank to generate substantial profits from your deposit, all the while providing you with a relatively small percentage of the earnings.
Banks Are Funded by You
It’s crucial to emphasize that this idea is fundamental to the entire banking system, including SVB. Without this process, banks would be unable to generate the necessary profits to sustain their operations and provide the services we rely on. As a result, it’s essential to have a solid understanding of the money multiplier effect in order to fully comprehend SVB’s function in the broader financial landscape.
Why SVB Crashed?
The bank, specializing in tech startups and businesses, experienced a surge in deposits during the COVID-19 pandemic due to the thriving digital and delivery services. To maximize returns, the bank invested 90% of these deposits in US government bonds.
Increased Interest Rates
Nonetheless, with the US Federal Reserve’s decision to raise interest rates, exchange rates increased, resulting in a decline in the bond values. This posed challenges for the bank, particularly as the economic environment for the technology sector grew more difficult following the pandemic’s surge.
Just Trying to Survive
Many of the bank’s customers withdrew their funds to stay afloat, leaving the bank short on cash. To cover its losses, the bank had to sell its bonds at a significant loss, raising concerns about its financial stability. Within 48 hours, depositors panicked and withdrew enough funds to cause the bank’s collapse.
Who Caused the Crash?
Some attribute the Federal Reserve’s interest rate increase as the cause, while others argue the bank’s risk management was inadequate. James Angel, an expert on the regulation of global financial markets at Georgetown University, told Al Jazeera, “SVB collapsed because of a stupid rookie mistake with their interest-rate-risk management: They invested short-term deposits into long-term bonds. When interest rates rose, the value of the bonds fell, wiping out the equity of the bank.”
Poor Business Management
The occurrence of two bank failures in March 2023 has prompted specific individuals to participate in political discussions. Nevertheless, we must acknowledge trust’s importance in our banking system and the broader economy. Unfortunately, SVB Management did not act swiftly or intelligently in managing its primarily tech-focused customer base. This led to a bank run that caused the institution to crumble within a few short hours.
Undiversified Assets
Despite the CEO’s efforts to provide customers with confidence regarding the safety of their funds, an anonymous employee from SVB expressed disapproval of how the bank managed the situation. SVB was deeply engaged in the technology sector and had built a reputation for backing startups that more prominent financial establishments might deem excessively risky to invest money into. However, the bank ultimately failed due to hasty decision-making, inadequate crisis management, and a lack of diversification in investments.
What Happens Now?
The recent collapse of SVB bank has caused some concern within the US banking system. However, experts believe that there is no reason to expect wider implications for the industry. While there may be some localized instability, as evidenced by the dip in the crypto market on Saturday morning, the sector as a whole is expected to remain relatively stable.
Banking is Still Secure
SVB was a significant player in the banking industry, but its customer base was highly specialized, catering almost exclusively to the technology and VC-backed communities. Consequently, its collapse is unlikely to significantly impact other banks, which are more diversified across various industries, customer bases, and geographies. Nevertheless, there could be ripple effects on the US tech startup ecosystem if deposits held at SVB are not released quickly.
Filing for Bankruptcy
Following regulators’ takeover of SVB Financial a week ago, the bank has now filed for Chapter 11 bankruptcy protection in the US Bankruptcy Court for the Southern District of New York. This move will allow SVB Financial to continue its operations while searching for potential buyers of its assets, including SVB Securities and SVB Capital.
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