Updated: Sep 13
By Ville Rajala
The sudden collapse of the Silicon Valley Bank (SVB) on 10 March 2023 has sent shockwaves through global financial markets. SVB’s collapse is the second-largest bank to fail in US history, and reminiscent of the 2008 financial crisis. Many fear that the collapse will be a ‘Lehman-moment’, catapulting the world into another banking crisis. How can a bank that used to be the sixteenth largest in the US in 2022, tumble in less than 48 hours?
© Jacob Reynolds
The past week has been tumultuous in the global financial markets. Market volatility hitting record highs, it is clear that investors are anxious and uncertainty is spreading through markets like wildfire.
All of this started with the sudden collapse of SVB on 10 March, just 48 hours after the bank published huge losses on its investments in US Treasury bonds and announced intentions for significant capital raise.
The collapse has already caused global ripple effects as the following week the embattled Swiss investment bank Credit Suisse was faced with a crisis of confidence. SVB is amongst three banks collapsing in a short amount of time in the US, causing fears of a spreading banking crisis.
What Kind of Bank Was SVB?
On the surface, SVB was a typical regional bank handling tasks such as taking care of deposits and savings, issuing loans, and facilitating transactions for its clients. What set SVB apart from its counterparts was the clientele it served.
Foremost, SVB was the prominent funder of the tech startup sector by providing loans and facilitating banking services for emerging companies. It worked as an institution where venture-capital firms could park their money when distributing the funds to promising firms.
SVB’s whole business model essentially revolved around the technology sector, making the bank’s revenue stream highly concentrated.
What Caused the Collapse?
What in the end brought down SVB was a phenomenon called the bank run. In a bank run, a significant number of the bank’s customers want to withdraw money at the same time. However, due to mainly fractional reserve banking, the bank simply will not have enough money to pay out to all the depositors at the same time. This sparks concerns about how safe the bank is – prompting customers to withdraw their deposits.
In SVB’s case, the confidence in the bank started to deteriorate when, on 8 March, it announced that its investments in US Treasury bonds had generated tremendous losses. Its investment policy was to buy long-term assets like ten-year Treasury bonds to provide higher interest rates than other banks for deposits. SVB poured a staggering amount of its assets, approximately 124 billion dollars (114 billion euros), into its bond portfolio.
During the low-interest rate era, pouring money into Treasury bonds was a popular investment choice. However, when inflation started to pick up speed in the latter part of 2021 and expedited in 2022, the US Federal Reserve was forced to raise interest rates.
As the bond price and its interest rate are inversely correlated, meaning that if the interest rate increases the value of the bond decreases, the interest hikes began to eat out SVB’s bond portfolio. In the end, SVB’s portfolio was yielding a return of one point seven per cent, which is far from the current three-and-a-half per cent yield of a ten-year US Treasury bond.
In late 2022 and during the start of 2023 the interest rates kept climbing, and SVB’s portfolio started to collapse in value. As the interest rate environment did not show signs of improvement and the tech sector, which was SVB’s main revenue source, was facing major difficulties, the bank did not have any other option than to sell some of its holdings at a steep loss.
The loss was a staggering two billion dollars. The massive asset sell-off sparked fear amongst the SVB customers and confidence started to deteriorate. Things took a turn for the worst when the bank announced that they were doing a capital raise, which solidified the rumour that the bank did not have enough cash at hand.
This sparked more people to withdraw their holdings until SVB declared bankruptcy on 10 March. After that, the SVB’s management was taken over by the Federal Deposit Insurance Corporation (FDIC).
The past week the markets have been controlled by uncertainty, and stocks around the globe have had one of the worst weeks since the financial crisis of 2008. No other institution has been hit as hard as the Swiss-based investment bank Credit Suisse.
The scandal-riddled bank, which made headlines last October for the increased spreads of its own Credit Default Swaps indicating the bank’s greater risk of default, has found itself in the middle of another confidence crisis.
At the worst point during the past week, Credit Suisse’s stock was in free fall – falling over 30 per cent during one trading day. As one of the 30 banks deemed to be ‘too big to fail’, and with a little over one trillion Swiss francs (one trillion euros) worth of assets under management, the failure of the swiss bank would have catastrophic consequences for the global financial system.
The Swiss regulators facilitated a deal in order to sell Credit Suisse to its competitor UBS, which paid just over three billion dollars (2.8 billion euros) for the troubled bank.
A New Banking Crisis?
The past week has been filled with uncertainty. The sudden collapse of SVB and struggles at Credit Suisse have cast doubts over the health of the global financial markets. The uncertainty started to alleviate, at least in US markets, when the shares of hard regional banks started to rise again.
Confidence-boosting was the multi-billion dollar deal to rescue the First Republic Bank, which was also severely hit by the loss of confidence in light of the SVB’s collapse. However, central banks, are in a difficult situation as inflation is not yet under control. The regulators need to walk on a tightrope when deciding which type of policy approach to utilise.
Expansionary monetary policy - which aims at making lending easier or pumping money into circulation - could possibly lead to an increase in inflation. On the other hand, hiking interest rates would slow the economy down even more as the cost of borrowing increases.
The rescue plan for Credit Suisse followed through, and UBS bought the bank for 2 billion dollars (1.8 billion euros). With this shot-gun marriage, facilitated by the Swiss government and regulators, the aim was to restore confidence in the Swiss banking system.
However, it is yet to be seen whether the merger alleviates the fears of a systemic banking crisis as proper access to Credit Suisse’s books is not yet known.
What makes the current situation different from 2008 is that, back then, banks all across the world gambled hard on mortgage-related financial products and highly complex derivatives. In the current situation, the main cause of headaches is the rapidly rising interest rates.
Globally, banks are still adjusting their portfolios and operations to the high-interest environment. Over a decade of low-interest rates, banks and customers have been accustomed to the ‘normalisation of cheap money’.
The nature of the recent bank defaults is, therefore, different. It is more a cause of internal mismanagement, skyrocketing interest rates, and poor investment results. The near future will have to show whether more banks will see bankruptcy or whether the financial sector is able to adjust to the new reality.
Sources: New York Times, Bloomberg, BBC, the Guardian, Business Insider, Financial Times
Written By Ville Rajala