Why did Silicon Valley Bank fail, and is a financial crisis next? | Banks

The collapse of Silicon Valley Bank (SVB) has sent shock waves through financial and technology circles.

On Friday, US regulators seized the assets of the Santa Clara, California-based bank after depositors began withdrawing funds en masse amid fears about the lender’s financial health.

Since then, financial regulators around the world have raced to contain the fallout from SVB’s collapse, the biggest bank failure in the US since 2008, and bolster confidence in the global financial system.

Why did SVB collapse?

As SVB’s name suggests, the bank’s business focused heavily on American technology startups. During the COVID-19 pandemic, the lender saw a surge in deposits as technology companies profited from providing entertainment and delivery services to people confined to their homes.

SVB invested much of this cash in US Treasuries – traditionally one of the safest types of investment.

SVB’s problems began when the U.S. Federal Reserve began raising interest rates last year in response to rising inflation, causing the value of those bonds to fall.

As financial conditions for the technology sector tightened following the pandemic boom, many of SVB’s clients began drawing on their funds to stay afloat. Short of cash, SVB was forced to sell its bonds at heavy losses, raising concerns about its financial health.

Within 48 hours, frightened depositors had withdrawn enough money to cause the bank to collapse.

“SVB collapsed because of a stupid rookie mistake with their interest rate risk management: They invested short-term deposits in long bonds. When interest rates rose, the value of the bonds fell, wiping out the bank’s equity,” said James Angel, an expert on global regulation financial markets at Georgetown University, to Al Jazeera.

“This is the same phenomenon that wiped out the American savings and loan industry in the 1980s. Some people never learn.”

Campbell R Harvey, a professor at Duke University’s Fuqua School of Business, said SVB’s problems were a lesson in the need for banks to diversify their assets.

“It seems like it catered to a certain clientele and we all know technology has taken a hit – and if you’re undiversified, you’re going to take a hit too,” Harvey told Al Jazeera.

“Your loan book needs to be diversified,” Harvey added. “It is not obvious that this bank actually did this.”

What has been the consequence of SVB’s collapse so far?

Two days after SVB’s collapse, US regulators seized assets from Signature Bank, a New York-based lender known for its dealings in the cryptocurrency sector, marking the third-largest bank failure in US history.

In an effort to stem the fallout, US regulators announced on Sunday that they would guarantee all deposits at both lenders.

The Federal Reserve also unveiled a lending program, the Bank Term Funding Program (BTFP), aimed at boosting confidence in the financial system by allowing banks to borrow directly from the Fed to avoid having to rely on loss-making bond sales.

US President Joe Biden has sought to reassure the public that the situation is contained, saying: “Americans can have confidence that the banking system is safe.”

Nevertheless, bank stocks, including those of the US “big four” – JPMorgan Chase, Bank of America, Wells Fargo and Citibank – have fallen sharply on fears of contagion in the financial sector.

First Republic Bank, a mid-tier bank based in San Francisco, California, saw its stock price drop as much as 60 percent.

Bank shares in Europe and Asia have also taken a significant hit.

In the United Kingdom, financial authorities announced that they had facilitated the sale of SVB’s local unit to HSBC, Europe’s largest bank, to secure 6.7 billion pounds ($8.1 billion) in deposits.

Canadian regulators announced they had temporarily taken control of the country’s SVB unit, while Germany’s federal financial regulator said it had temporarily closed the local branch of the lender.

How important was SVB to the banking industry?

SVB was the 16th largest bank in the United States and has been described as a mid-tier lender rather than one of the largest players.

“It’s an unusual bank because it’s not one of the big banks, even though it’s significant,” Harvey said.

In December, the lender had $209.0 billion. in assets and $175.4 billion. in total deposits, according to the Federal Deposit Insurance Corporation.

By comparison, JPMorgan Chase, the largest bank in the United States, had assets worth $3.67 trillion last year.

However, SVB had an overall influence in the technological ecosystem. The lender was well-connected among the Silicon Valley elite and had a reputation for backing startups that larger institutions might find too risky to lend to.

SVB’s failure reportedly left some tech executives scrambling to switch banks and explore options to pay staff over fears they would not be able to access their funds.

Although SVB’s customers ultimately had their deposits guaranteed, the full impact of the lender’s implosion on the startup scene may not be visible for some time.

Could SVB’s collapse cause a financial crisis like 2007-2008?

While the fallout from SVB’s collapse is still unfolding, economists broadly agree that its failure is markedly different from the implosion of financial institutions, such as Bear Stearns and Lehman Brothers, that triggered the global financial crisis of 2007-2008.

Unlike institutions such as Lehman Brothers, SVB’s business was concentrated in one sector and had relatively few connections with other banks.

“The SVB situation certainly has people worried, but I don’t think it will turn into a Lehman-type situation, especially given how aggressively the Fed has intervened, including by promising to protect even uninsured deposits,” David Skeel, professor in corporate law at the University of Pennsylvania Law School, told Al Jazeera.

“I think any direct fallout is likely to become clear fairly quickly, although it’s certainly possible that there are other banks that are in a similar predicament because of the rate hike.”

Financial regulation has also been tightened significantly since the 2007-2008 crisis.

“Fortunately, the increased capital requirements imposed after the 2008 crisis appear to be paying off,” Angel said.

“Banks are now required to hold much more capital than before, which makes them much less risky. Even the banks that have made stupid mistakes mostly lose their own money, not depositors’ money.”

William T Chittenden, associate professor of finance and economics at Texas State University, said he believes the contagion from SVB will be limited.

“With the BTFP, banks will be able to borrow against these securities at face value, allowing banks to avoid selling them at a loss. This should provide banks with the liquidity they need to meet any unexpected cash requirements from their depositors, Chittenden told Al Jazeera.

“We will know if this works or if there is widespread fallout from SVB’s failure in the next few days,” he added. “The vast majority of banks in the US are financially sound, and with the new BTFP, depositors should feel good.”

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