By: Rodrigo Erthal
On March 10 this year, the “Silicon Valley Bank” had the most significant bank failure in the US since the 2008 global financial crisis. The bank was known for lending money to tech companies and start-ups in the Silicon Valley area, recognised as the technological hub of the world.
Before US regulators interfered to take control, Silicon Valley Bank's clients hastily withdrew their money from the California-based lender. The collapse, however, frightened the markets and added to the pain felt by weaker financial institutions that were already dealing with the unintended consequences of skyrocketing interest rates and self-inflicted injuries.
The problems began to rise 48 hours before the US government’s Federal Deposit Insurance Corporation took control of the bank. When the bank cashed out on US government bonds to pay their depositors, it took a multi-billion dollar loss. It also tried to sell shares to ease its payments, which proved unsuccessful—this initiated panic among the depositors and shareholders, ultimately leading to its downfall.
However, the moments that led to this downfall began much earlier than that time. First, the bank invested billions in cheap US government bonds when the interest rates were nearly zero. US bonds, by Investopedia's definition, "are a form of government debt issued to American citizens to help fund federal expenditures." When they have low-interest rates, they become more attractive because it becomes cheaper to borrow money. Additionally, an important thing to know is that these said bonds are long-term and considered extremely safe, so they do not yield as much return. SVB continued receiving money from start-ups and other companies, with an increase of 320%, from $62 billion to $198 billion between 2019 and 2022. Then when inflation began to rise, the Federal Reserve System started to hike interest rates which occurred nearly one year ago. Following the rate increase, SVB's portfolio burned as the yield for their bonds would return an average of 1.79% instead of the regular 3.9% that would've been produced after ten years. With higher interest rates, it is harder to borrow money, so startups enter a capital drought, which forces them to draw their funds from the bank to fund operations and produce growth.
With a mountain of unrealised losses, a famous Bank run occurred. This is when customers try to retrieve their money all at once because they think the bank might collapse at some close point. These occurrences led to the 48 hours before the intervention, where the bank sold their securities ("safe" bonds) at a loss to increase their capital. They also sold $2.25 billion in new shares. When this happened, vital venture capital firms advised everyone to collect their money from the bank. This led to SVB's stock plummeting by an astonishing 60%, dragging down other banks. This caused Wall Street to fear another 2008 financial crisis. After all this chaos, the FDIC intervened and stopped the Bank run and the possibility of trading the bank's shares.
One of the other banks that came down with SVB was Credit Suisse (CS), one of Switzerland's largest banks. Their stock dropped by 30%, which caused the authorities to backstop the Swiss bank. The Corporate Finance Institute defines a backstop as " a financial arrangement that creates a secondary source of funds in case the primary source is insufficient to meet current needs. It can also be considered an insurance policy that covers the inadequacy of a source of funds." This calmed the market down a bit, however, only inside the country, as there was still tension and problems with the methods in international markets. Stakeholders and customers were worried that the bank did not have a good plan to survive a long-term decline, and began pulling out.
To reduce panic for these two banks, a plan was instilled for them to be rescued. In the European-based bank, their direct rival, UBS, agreed to loan, or buy the bank, for $225 billion dollars. This amount is protected by the Swiss state and protects against potential losses. On the United States side, the First Citizen Bank took a bid at the Silicon Valley Bank and was helped by the Federal Reserve with a hook of around $140 billion dollars. This resulted in the ease of banking markets and the unity of them as well, as various banks across the globe tried to lend money to these banks to ease the crisis, which resulted in positive returns.
Even though a few problems have been solved there is still a fear of recession in the world. Goldman Sachs believes that in the following 12 months there may be an increased chance of a US bank recession. They believe there is a 35% chance that this occurs, compared to the previous 25% chance before the meltdown.