In a stunning turn of events, Silicon Valley Bank (SVB), one of the 20 largest US commercial banks, has collapsed within just 48 hours, becoming the second-largest financial institution failure in the history of the United States. The US Federal Deposit Insurance Corporation (FDIC) has taken over the bank’s supervision as SVB failed to repay its depositors, posing a significant threat to the start-up and technology industries that it had been supporting. The bank’s failure could have huge repercussions on the start-up and technology industries, despite experts’ efforts to address concerns of a wider contagion.
What is SVB?
Silicon Valley Bank (SVB) was established in 1983 with a focus on providing financial services to IT entrepreneurs. Over the years, it became a crucial source of funding for nearly half of the venture-backed technology and healthcare start-ups in the United States. Despite its relative obscurity outside of Silicon Valley, SVB grew to become one of the top 20 US commercial banks, boasting $209 billion in total assets at the end of last year, according to the FDIC.
You can also read: Can Bangladesh avoid Chinese debt trap?
What had happened within the “48 hours”?
Silicon Valley Bank’s bankruptcy is the greatest since Washington Mutual’s collapse in 2008, a defining event that sparked a financial crisis which crippled the US economy for years. The 2008 financial crisis led to stricter regulations in the United States and abroad. On Wednesday, when SVB said it had sold a bunch of securities at a loss and would sell $2.25 billion in new shares to fix its balance sheet, situations began to go south. Stock in the bank started falling Thursday morning, and by afternoon it was dragging down shares in other financial institutions as investors feared about a recurrence of the US financial crisis of 2007-2008. And, by Friday morning, trading in SVB shares had been discontinued, and the company had abandoned efforts to raise funds or find a buyer immediately. California regulators shut down the bank and placed it under the supervision of the FDIC.
The prompt takeover of FDIC
The FDIC has taken over as receiver, which means it will liquidate the bank’s assets to repay its creditors and depositors. All insured depositors will have full access to their guaranteed deposits no later than Monday morning, according to the FDIC, an independent federal body that insures bank deposits and supervises financial institutions. It stated that uninsured depositors will receive an “advance dividend” within the following week. “The majority of Silicon Valley’s business customers had account balances exceeding $250,000 guarantees deposits up to $250,000 maximum. Friday around noon, the FDIC took over the SVB. Usually, it waits until the markets close. “SVB’s condition deteriorated so quickly that it couldn’t last just five more hours,” stated Better Markets CEO Dennis M. Kelleher. “That’s because its depositors were withdrawing their money so fast that the bank was insolvent, and an intraday closure was unavoidable due to a classic bank run,” he added.
Why SVB has failed?
The bank fell victim to a confluence of factors. Although the specifics of the tech-focused bank’s sudden demise were a mess, it was clear that the Federal Reserve’s aggressive interest rate hikes over the past year were a major factor. These hikes had impacted financial conditions in the start-up industry, where the bank was a major player.
The Federal Reserve was the first to act, beginning its rate-hiking cycle a year ago in an effort to slow inflation. The Federal Reserve took aggressive action, and increasing borrowing prices disrupted the momentum of tech companies, which had previously benefitted SVB.
Moreover, rising interest rates, failure to issue initial public offerings (IPOs), and a shortage of cash reserves prompted clients of SVB to start withdrawing their funds. The value of long-term bonds purchased by SVB and other banks during the period of ultra-low interest rates was also diminished by higher interest rates. According to Moody’s chief economist Mark Zandi, the higher rates lowered the value of SVB’s treasury and other securities, which the bank needed to pay depositors. The average yield on SVB’s $21 billion bond portfolio was 1.79 percent, compared to the current yield on 10-year Treasury bonds, which is approximately 3.79 percent. These factors triggered a run on deposits that forced the FDIC to take over SVB. Concurrently, venture finance began to dry up, prompting startups to withdraw SVB-held funds. Hence, the bank was sitting atop a mountain of unrealised losses in bonds while the rate of customer withdrawals accelerated.
Tech companies at risk
SVB was more eager than other banks to collaborate with tech businesses, such as by facilitating home loans for early employees. Moreover, SVB was especially receptive to lending money to tech firms even though these companies lacked free cash flow (since tech start-ups typically lose money in the early stages of their operation) and a significant portion of assets (because when they emerge, start-ups typically have little more than the brains of their founders and early workers).
Although SVB was a major source of funding for start-ups, those businesses are now facing difficulties in withdrawing funds, paying employees and meeting other essential operating costs. Concerned, Ashley Tyrner, the founder of the health food delivery firm FarmboxRx, stated, “Now that the bank has folded, I just want to know what happens next.” She continued, “The FDIC covers $250,000, but am I going to recover my whole 8 figures?”
Contagion worries: Is Signature Bank a victim of recent financial turbulence?
The collapse of SVB is an unfortunate news for whoever ends up paying for the bank’s mistakes. Shares of banks are falling, and it’s not out of the question that problems at SVB may spread to other financial institutions. Aaron Klein, a senior economics fellow at the think tank Brookings Institution, stated, “There is always a risk of contagion, because banking is fundamentally a game of trust and confidence. When they erode, the system becomes less stable.”
Quite recently, Signature Bank, a New York bank with a big real estate lending business that recently tried to get cryptocurrency deposits, shut down without warning on Sunday after regulators said that keeping the bank open may affect the stability of the entire financial system. The fear surrounding Silicon Valley Bank, which officials seized on Friday, has affected Signature to a certain extent. Its collapse highlights the difficulties faced by smaller and medium-sized banks, which typically specialize in fewer areas of business and serve a more limited customer than behemoths like JPMorgan Chase or Bank of America. So, they are particularly susceptible to conventional bank runs. Last week, Silvergate Bank, another cryptocurrency-focused bank, was forced to voluntarily close. Signature Bank’s closure, with assets of less than $100 billion, is a setback for many professional services companies that had grown to rely on it. The bank has historically specialized in supplying legal firms with financial services, including escrow accounts to hold client funds and other services.
As the story spread, so did anxiety about the underlying dangers in the banking industry and its sensitivity to the growing cost of money, leading some analysts to predict further pain for the sector. Christopher Whalen, head of Whalen Global Advisors, stated, “There could be a bloodbath next week as short sellers are out there and they are going to attack every single bank, especially the smaller ones.”
