The financial world is always brewing with news that catches the attention of both the investors and analysts alike. This week however the hot topic was about the collapse of a bank. And not just any bank, it is America’s 16th largest bank with roughly $209 billion in assets. And it is regarded as the second largest bank failure in the country’s history after Washington Mutual (later acquired by JP Morgan & Chase). The fall of Silicon Valley Bank was very fast and not that many were hoping for.
Source:- https://www.thehindubusinessline.com/economy/silicon-valley-bank-collapse-to-impact-indian-start-up-ecosystem-experts/article66610102.ece
This news has caused mass panic in the US stock market so much so that the NIFTY has collapsed by roughly 12% over the last five trading days. The SVB has lost more than 60% of its value in a single day. This news has been the talk of the town and now everyone is wondering whether the fall of this bank could have a domino effect that will result in a financial crisis similar to 2008. Keeping aside all the rumors going on, let's first understand what led to the bank failing.
Silicon Valley Bank was a commercial bank headquartered in Santa Clara, California and was the 16 th largest bank in the United States at the time of it’s failure on March 10, 2023, and was the largest bank by deposits in Silicon Valley. It started as a small California lender 40 years ago and built it's way up during the tech boom outmaneuvering Wall Street giants such as JP Morgan, Goldman Sachs and Morgan Stanley. The bank is known to lend money to tech based startups. But its dependent relationship with tech startups backfired as the tech world was rocked by rising interest rates that increased SVB’s funding costs while simultaneously causing the biggest collapse in tech valuations since the dotcom era.
Source:- https://www.thehindubusinessline.com/economy/silicon-valley-bank-collapse-to-impact-indian-start-up-ecosystem-experts/article66610102.ece
Some of the startups include Circle, Roku, BlockFi and Indian startups like Shaadi.com, BlueStone, Naaptol and InMobi among others. SVB used to give loans directly to these startups or give loans to venture capitalists and private equity firms who in turn invested in these startups.
Now after receiving this funding they spend some money on immediate expenses like paying for salaries, build operations, test products and other day to day activities. Rest of the money or rather 50% of these startups which are in US Tech and live sciences, used to keep their money in the Silicon Valley Bank.
In a regular banking setup, customers deposit their money with the bank and then the bank gives out loans to borrowers who are in need of it. They charge higher interest rates from the borrowers and pay a comparatively less interest rate to the depositors. The difference between the two is known as “spread” which is basically the profit for the bank. In the case of SVB, they had depositors who were parking their excess funds in the bank but on the flip side the problem was that not too many organizations and especially startups were borrowing money.
Well, the reason is simple - the escalating interest rates!
Every now and then we see the Federal Reserve hiking up the interest basis points. Currently the rate of interest is roughly to around 5%. In this case, the business loans can go up to 7% to 8% which is fairly high in the US economy. So as a result SVB was firstly facing an operational problem. Now because of this, startups are not willing to take fresh loans. Also many new age startups who were planning on IPOs are deferring it. For example in India we had Mama Earth and Byjus and other bunch of startups which are in their unicorn level having planned an IPO this year but many of them have postponed the IPO plans seeing the unfavorable market conditions.
So when these startups started facing a cash crunch to fund their operations they all started to withdraw their money from Silicon Valley Bank. The rate of cash withdrawals accelerated and a lot of parties started asking for their money back.
Adding to the fuel, there were many bad investments on behalf of the Silicon Valley Bank. The bank heavily invested in government and US Treasury bonds that had long maturity dates. So if they by any chance go and sell these bonds before the maturity in the secondary market they will have to sell it at the existing market price. Now the catch to all of this is that when the interest rates are up, then the bond prices tend to fall and vice versa. Bond prices and interest rates share a negative relationship to each other. Hence, SVB had to sell its bond portfolio for a loss of $1.8 billion to have enough cash to give to it's depositors.
Source:- Financial Times
And because of the depositors lining up to withdraw their cash , left the bank with no option but to sell its bond securities before maturity date. The ‘bank run’ because of panic and anxiety led to the chaotic fall of SVB. With that, prominent VC (venture capital) investors who are highly respected in the startup world such as Peter Thiel and Gary Tan created panic with one of the investors advising their portfolio company to withdraw all the money. And the bank, in order to create that additional liquidity, had to sell these assets at a massive loss.
As per the recent developments the stock price dropped another 60% in the premarket on Friday (March 10th 2023) before being halted- and shares never reopened for trading. The bank also failed in raising capital by selling its stocks to investors and additional $500 million of mandatory convertible preferred shares. At last the financial regulators (The California Department of Financial Protection and Innovation) had to shut down Silicon Valley Bank on Friday and take control of its deposits, less than two days after the bank tried to persuade clients not to pull their money over concerns it was running low on available cash. The regulator has appointed the Federal Deposit Insurance Corporation as the receiver.
Picture Credit:- Financial Times
The F.D.I.C. created a new bank, the National Bank of Santa Clara, to hold the deposits and other assets of the failed one. The agency said in a news release that the new entity would be operating by Monday morning and that checks issued by the old bank would continue to clear.
The F.D.I.C has only guaranteed bank deposits of up to $250,000, a sum well under most of its early-stage tech and venture capital client’s account balances. The depositors can now only hope to get all their due money back. They want the bank to be bought under a receivership and that its new owner will reopen accounts and resume lending.
And as for the matter of will this be the genesis for the next 2008 financial crisis, where because Lehman Brothers collapsed, other banks too collapsed with it. I think not. The reason is that in the 2008 crisis, there was something called a subprime loans. So these were packaged as investment grade instruments, and not only Lehman Brothers had access to that, but a wide range of banks had access to that. In the current situation that we are analyzing, these are government and US Treasury securities. These are safe assets. Subprime loans were unsafe assets. The underlying to both the cases are different.
In the 2008 crisis, the underlying was really bad to begin with. Those were subprime loans. Those were bad loans. Here, the securities underlying structure is strong enough. It is just a credit crunch that the bank suffered. However one major lesson for all of us is that putting all the eggs in one basket is inadvisable. Portfolio diversification is important which SVB clearly didn't take into account.
Silicon Valley has already been in the news for the past few months, with first tech layoffs reaching heights and now a bank collapse. Lets just see how this home for technology companies and a thriving financial environment navigates these challenges and continues to adapt to a rapidly changing world and come back stronger than before.
And just as we were reeling from this bank failure catastrophe, the latest news is that the regulators have now closed a New York based Signature Bank on Sunday the 12th of March,2023. The casualty is the third largest failure in U.S. banking history. Well, it looks like we'll have to keep an eye on the banking industry and hope for the best. Until then stay financially savvy, folks!
Article by:- J Shree Nidhi
Edited by:- Natasha
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