Over the past weeks, there has been a lot of talk regarding the failure of Silicon Valley Bank. You may hear words in the media like bank failure, bank runs, contagion, Insured vs uninsured deposits, and many other words that are thrown around surrounding this. But what does this really mean for you, the consumer, and the broader banking and financial system?

Some Background on SVB

Silicon Valley Bank (SVB) was a regional midsize bank located in California. It saw a huge boom during the pandemic as tech startups, which were it’s main clients, saw huge inflows of cash. As any bank does, they hold a fraction of cash in reserves as required by federal law, and the rest is lent out as loans or used to buy assets to earn a return and balance the liabilities they hold (the deposits).

So, What Actually Happened?

With all this cash, SVB decided to buy US Government Treasuries (T-Bills) which are widely considered one of the safest assets in the world. Intuitively, this is smart play as bond prices over the past decade have been stable and earned small returns. However, the price of bonds is inversely related to interest rates, and anyone who has been paying attentions to finance the past year will know the US Federal Reserve has been increasing the Federal Funds Rate rapidly to try to slow inflation.

So, as the astute reader may realize, raising interest rates + huge bond portfolio = massive devaluation of these bonds. With short term rates raising about 4%, SVB’s bond portfolio fell more than 20%, a huge loss on a portfolio with billions of dollars’ worth of bonds.

This drove down the value of their assets and created panic for the people who held assets at the bank, resulting in a bank run. This is when depositors rush to the bank to take out their cash and in doing so the bank must liquidate its assets to come up with the cash. Since the bonds were so devalued they had less assets than deposits and could not meet demand, resulting in insolvency; the bank could not meet the demand for withdrawals.

How Does this Affect the Banking System?

The big concern stemming from this is that other similar banks may have the same fate as SVB. If there is one bank that collapses due to poor oversight and risk management, are there others that may do the same? This is the concern and why we see so many depositors taking their deposits from small regional banks and putting them into the large banks, the JP Morgans of the world, as if there is a banking crisis, the government would surely have to insure and bail out these giant banks.

There have been ripples around the world as people are frantically trying to figure out if their bank of choice is sitting on solid assets and whether or not they might face solvency issues.

The Bottom Line

Although the collapse of SVB does not directly affect consumers like me and you, the scare can be felt far away from California. If one bank can become insolvent and lose all uninsured deposits and equity value, could it happen to yours? This is the big concern, not to mention the vast decline in the financial sector of the stock market. Overall, it is impossible to tell if this will turn in to a full-blown global banking crisis, however it is certainly scary territory, and only time will tell how far this will go.

 

Figures and information used was from the following Wall Street Journal Article: https://www.wsj.com/articles/silicon-valley-banks-meltdown-visualized-3da2263b?mod=WSJ_ENG_MRKT_RHS_SVBMLTDWNVSLZDMAR2023_ADHC_NAH