Bank failure/collapse is not a new phenomenon. In recent history, there have been 565 bank failures from 2000 to 2023, of which 465—or 82%—occurred between 2008 to 2012. Bank failures hit a peak in 2010 at 157 in just one year. The reasons for bank failures are complex, and there are often multiple factors at play. Here, we briefly analyze what happened with SVB. Let’s dive in and see if we can understand why events occurred the way they did with the SVB.
Although the bank collapse itself only happened in March, understanding it requires us to travel back a couple of years. But before that, let’s take a quick look at the basic function of a bank. Simply put, people and companies deposit money in banks, and the banks pay interest back to these depositors. Depositors receive this interest and have the option to get their deposit money back from the banks at a later time. To make a profit, banks lend out the deposited money to borrowers, typically charging a higher interest rate than they pay to depositors. Additionally, banks may invest the money into stocks, bonds, or other assets to generate better returns or to diversify the bank’s investment risk. To pay back depositors, banks maintain some amount of liquidity, and when needed, will use their reserve funds, generate new funds by raising fresh capital, or borrow from other banks and financial institutions.
During the pandemic, interest rates were reduced heavily, nearly reaching 0% at one point. This was done to offer easy access to credit to make it easier for Americans and for businesses to spend, keeping the economy functional. Seeking higher investment returns in 2021, the SVB began shifting its portfolio from short-term to long-term Treasury bonds. Treasury bonds are bonds that are offered by the US Treasury, and pay back interest over time to the buyer. Generally, as a rule, the value of bonds varies inversely with Federal Reserve (Fed) interest rates. The higher the Fed interest rates, the lower the value of the treasury bond.
With tech companies flourishing and large sums of money invested in Treasury bonds, the SVB was in a good position. However, as the world began to recover from the pandemic, signs of inflation in the US economy started to surface. In 2022 and early 2023, due to rising inflation fears, the Fed raised interest rates multiple times. This caused the market value of the bonds being held by SVB to decrease significantly in 2022 and into 2023, causing unrealized losses on the SVB portfolio. Higher interest rates also raised borrowing costs throughout the economy, and some Silicon Valley Bank clients started pulling money out to meet their liquidity and operational needs.
SVB was struggling to service withdrawals by its depositors as it had already loaned out or invested the deposit money. To get the money they needed to pay back the depositors, the SVB sold many of its investments for a lower price than it bought them. SVB was operating at a loss. To raise cash to service the withdrawals, the bank sold over US $21 billion worth of securities, borrowed $15 billion, and decided to hold an emergency sale of some of its treasury stock to raise $2.25 billion. The bank made an announcement on Wednesday, March 8th that they had sold its bonds at a loss and had sold shares to make up the money, causing investors and financial analysts to notice the dangerous situation the bank was in. The announcement, coupled with warnings from prominent Silicon Valley investors, caused a bank run as customers withdrew funds totaling $42 billion by the following day, Thursday.
Fearing for their investments, people and businesses who had deposited money in the bank rushed to remove their funds, and the SVB's share value plummeted. As more and more people started to withdraw their money from the bank, the SVB didn't have the cash they needed to fulfill their obligations to their customers. All of this led to a collapse of the bank. Citing inadequate liquidity and insolvency, and to maintain confidence in the banking system, both the California Department of Financial Protection and Innovation and the Federal Deposit Insurance Corporation moved quickly and seized the bank, reassuring the public that they would repay customer deposits. This also served to prevent a domino effect on other banks.
The SVB is only one of the many financial institutions that have been facing difficulties over the past few weeks. Other banks, including Credit Suisse, First Republic Bank, and PacWest Bancorp, have been dealing with similar struggles. In fact, reports indicate that, since the end of 2022, US banks have accumulated $620 Billion in unrealized losses, which means that their investments in government bonds and assets have been losing value but have not been sold at a loss yet. It remains to be seen what the long-term effects of the SVB collapse will entail.
There are multiple dimensions to unpack with regard to bank collapses. Please stay tuned for our future articles to discuss these in more detail.
