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 are financial institutions where we deposit our money, with the expectation that it will be available for future use. However, what many people don't realize is that when we deposit our money into a bank, we engage in a variety of financial activities that can 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. This process, known as the money multiplier effect, allows the bank to earn a significant profit on your deposit while only giving you a small percentage of the return.
Banks are Funded by You
It's important to note that this concept is fundamental to the entire banking system, including SVB. Without this process, banks would not be able to generate the profits necessary to sustain their operations and provide the services we rely on. Therefore, it's essential to have a basic understanding of the money multiplier effect in order to fully comprehend the role of SVB within 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
However, when the US Federal Reserve increased interest rates, the exchange rates rose, causing the value of the bonds to drop. This created problems for the bank, especially as economic conditions for the tech sector became more challenging after the pandemic boom.
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?
While many blame the Federal Reserve's interest hike, others say the bank failed to manage the risk properly. 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 recent collapse of two banks in March 2023 has spurred some individuals to engage in political discourse. However, it is crucial that we recognize the significance of trust in our banking system and economy as a whole. 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 attempts to reassure customers that their funds were secure, an unnamed SVB employee criticized the bank's handling of the situation. SVB was heavily involved in the tech industry and had cultivated a reputation for supporting startups that larger financial institutions might consider too risky to invest in. 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 have a significant impact on 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 the takeover of SVB Financial by regulators 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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