Silicon Valley Bank Crisis: Reasons and Impact in near Future
After Silicon Valley Bank and Signature Bank failed, bank stocks all across the world fell on Monday even as President Joe Biden promised to safeguard the security of the American financial system.
Authorities in the America applied emergency measures on Sunday to restore trust in the banking system after the crash of Silicon Valley Bank threatened to spark a larger financial crisis.
Why did Silicon Valley Bank fail?
Silicon Valley Bank was impacted hard by the fall in technology stocks over the previous year as well as the Federal Reserve’s aggressive effort to hike interest rates to battle inflation.
For the past few years, the bank has purchased bonds worth billions of dollars with consumer deposits, much like a traditional bank would. Although these investments were typically safe, their value declined since they carried lower interest rates than a comparable bond would have if it had been issued in the present atmosphere of rising interest rates.
In most circumstances, this is not a concern because banks store those for an extended amount of time, unless compelled to sell them in an emergency.
Yet, the majority of Silicon Valley’s clients were start-ups and other tech-focused enterprises that had become increasingly desperate for finance over the preceding year. Owing to a dearth of venture capital investment, companies were obliged to rely on their existing cash reserves, which were usually deposited at Silicon Valley Bank, which was positioned in the centre of the tech startup universe.
Silicon Valley customers started taking their deposits out as a result. That wasn’t a big deal at first, but the withdrawals forced the bank to start selling its own assets to meet consumer withdrawal requests. Because Silicon Valley customers were primarily corporations and the rich, they were likely more concerned about a bank failure because their accounts exceeded the $250,000 government-imposed cap on deposit insurance.
This necessitated selling generally safe bonds at a loss, and the losses built up to the point where Silicon Valley Bank was practically bankrupt. The bank attempted to raise extra capital from outside investors but was unable to find any.
The flashy tech-focused bank was taken down by the oldest problem in banking: a run on the bank. Bank regulators had little alternative but to seize Silicon Valley Bank’s assets in order to protect the bank’s assets and deposits.
What was the significance of SVB in the banking industry?
SVB was the 16th-largest bank in the United States, and it has been classified as a mid-tier lender rather than a big participant.
“It’s an odd bank in that it’s not one of the large banks, despite its size,” said Campbell R Harvey, a professor at Duke University’s Fuqua School of Business.
According to the Federal Deposit Insurance Corporation, the lender has $175.4 billion in total deposits as of December and $209.0 billion in assets. The largest bank in the US, JPMorgan Chase, had assets of $3.67 trillion last year.
SVB, however, had a significant impact on the tech industry. The lender had a good reputation for supporting startups that larger banks would have deemed to be too risky to lend to and was well-connected among the Silicon Valley elite.
Other IT chief executives reportedly rushed to switch banks and looked into other methods for paying personnel after SVB’s insolvency because they were concerned they wouldn’t have access to their money.
Although the deposits of SVB’s customers were finally insured, the full impact of the lender’s collapse on the startup sector would not be felt for some time.
What may come after this?
There are still two significant issues with Silicon Valley Bank, but if they aren’t resolved right away, both of them could lead to other issues.
The most urgent problem is the size of the deposits at Silicon Valley Bank. The federal government insures deposits up to $250,000 but not deposits above that sum. Protected deposits would be available starting on Monday morning, according to the Federal Deposit Insurance Corporation.
Yet, due to the fact that Silicon Valley Bank’s clients were primarily startups and well-off tech employees, a distinctive feature of the bank was the vast majority of its deposits not being insured.
It will probably be necessary to release all of that money in a methodical manner because it is currently unavailable. But many businesses cannot wait weeks to have access to funds to fulfil payroll and office needs. There may be layoffs or furloughs as a result of that.
Furthermore, Silicon Valley Bank has yet to find a buyer. A stronger bank typically acquires the assets of a bankrupt bank, but no stronger bank has expressed interest in this case. A bank purchasing Silicon Valley Bank would greatly help to alleviate some of the challenges relating to the money that entrepreneurs are currently unable to access.
Is a financial crisis like 2007-2008 ahead?
Although the effects of SVB’s bankruptcy are still being felt, economists generally concur that it differs noticeably from the collapse of financial giants like Bear Stearns and Lehman Brothers that sparked the global financial crisis in 2007-2008.
SVB’s business was mostly focused on one industry and interacted with other banks not nearly as frequently as organisations like Lehman Brothers.
David Skeel, a professor of corporate law at the University of Pennsylvania Law School, told journalists that although the SVB situation “certainly has people worried, I don’t think it’s likely to turn into a Lehman type of situation.” This is especially true given how aggressively the Fed has intervened, including by promising to protect even uninsured deposits.
Although it’s possible that other banks are experiencing a similar situation as a result of the increase in interest rates, I believe any direct effects will likely become apparent fairly fast.
With the 2007–2008 crisis, financial regulation has also been severely tightened. Luckily, the additional capital requirements put in place following the 2008 financial crisis appear to be working, added Angel.
“Banks are significantly less dangerous now because they must have substantially more capital than they did previously. Even banks that have made careless errors typically lose their own money rather than depositors’ money.
Texas State University associate professor of finance and economics William T. Chittenden expressed his optimism that the spread of SVB will be minimal.
The BTFP will give banks the ability to borrow money against those securities at par value, preventing them from having to sell them at a loss. According to Chittenden, this should provide banks with the liquidity they require to meet any unforeseen demand for cash from their depositors.
In the upcoming days, he continued, “We will know if this is effective or if there is widespread consequences from SVB’s failure. “The vast majority of US banks are financially solid, and depositors should feel secure with the new BTFP.”
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