Silicon Valley Bank (SVB) was the 16th largest commercial bank in the US
Today, it is no more
SVB was based in California, US, and its collapse is the biggest financial disaster since 2008
[You may also read- the financial crisis of 2008 simplified]
Silicon Valley Bank collapsed because depositors rushed to withdraw their money, and the bank didn’t have enough liquidity (cash) to pay them.
In finance parlance, it is called a Bank Run.
Why did the banks not have enough cash?
This is because of a classic asset-liability mismatch.
When depositors park their funds in a bank, it is a liability for the bank as the banks are obligated to repay the money whenever depositors want it.
The banks can lend the deposited money to others or invest in securities. Loans or investments are an asset for the bank
It is to be noted that, most of the depositors in SVB were technology start-ups.
Though the bank was relatively small, it provided banking services to nearly half of US technology and life sciences start-ups last year. [As the name suggests, Silicon Valley Bank was created in 1983 to cater to the start-ups]
And during the pandemic, tech companies enjoyed a lot of profits. Immediately after the pandemic, the Fed slashed interest rates to almost zero which benefited start-ups even more. It led to an investment boom in the tech sector and they were flush with funds from venture capital funds. They deposited this money in SVB. To put things into context, in 2021, deposits of SVB surged from $102 billion to $185 billion. SVB has excess liquidity.
SVB invested this money ($91 billion) in long-term Government bonds. It means that the maturity term was longer and cash was locked away for more than 10 years. [To provide some context, until 2018, the bank was investing the majority of cash in securities with a maturity of less than 1 year]
Therefore, the liability of the bank was short-term in nature; the asset was long-term [asset-liability mismatch]
When did the trouble begin?
The trouble began when Federal Reserve increased interest rates in 2022 to combat inflation. And interest rates and bond prices are inversely related to each other. So, bond prices fell and the value of assets of SVB fell by $15 billion
[You may read this post to understand why bond price and interest rates are inversely related to each other- What is bond yield?]
Also, the start-ups had started facing a funding crunch due to increasing interest rates and started withdrawing money.
SVB had to sell bonds to repay their money
Because of the decrease in bond prices, SVB actually had to sell bonds at a loss.
On March 8th, SVB announced that it had sold bonds at a loss of$ 1.8 billion. It fuelled even more panic amongst the depositors
On March 9th, customers rushed to the banks and withdrew $42 billion in deposits (more than 1/4th of the total).
By 10th March, the bank collapsed and was taken over by the government
To sum up, the Silicon Valley Bank collapse happened due to:
- Asset-liability mismatch: The bank had excessive exposure to long-term Government securities and had to sell them at a loss when there was a run on the bank [50 % of assets in long-term bonds as compared to 29 % in India]
- The concentration of credit risk– most of its customers were start-ups. And when there was a slowdown in the sector, it affected SVB disproportionately
- Liquidity risk– most of its customers had bulk deposits. Therefore, more than 93 % of its deposits were not insured [the Government insures deposits of up to $250000 only]. It created more panic over concerns that SVB was running out of money to, meet liquidity requirements