It is often remarked that the banking industry is a perception-based industry. When the public loses faith in the bank, we experience a bank run i.e. depositors frantically withdrawing money based on fears that the bank will become insolvent. SVB’s (Silicon Valley Bank) failure is a classic example of a bank run.
So, let us dive into the nitty-gritty and understand the magnitude of the crisis and the bailout proceedings which followed last weekend.
How did SVB collapse?
SVB, which was established in 1983, specialises in banking for tech startups and venture-backed businesses. About half of the American venture-backed technology and healthcare startups received funding from it.SVB ranked as the 16th largest commercial bank in the United States, with its total assets being close to $175 billion at the end of 2022.
Let’s look at the timeline of the entire crisis.
8th March 2023:
SVB publicly announced its plan to raise more than $2 billion in the capital. SVB also declared that it sold approx. $21 billion of securities lead to an estimated $1.8 billion after-tax loss in the first quarter of 2023.
9th March 2023: A 60% decline in the bank’s stock price resulted in a market loss of around $80 billion, and depositors and customers, including many startups and venture capital organizations, rushed to withdraw their money out of panic.
10th March 2023: Friday’s premarket trading saw a further 60% decline in the stock before it was halted. The SVB was closed down, and the Federal Deposit Insurance Corp. (FDIC) seized its assets and took control of customer deposits.
Why did Silicon Valley Bank fail?
There are multiple factors which converged to cause the fall of the bank.
Increase in Interest Rates:
The SVB had purchased a sizable number of bonds over the previous years when interest rates were almost 0 per cent because it had plenty of cash. As the Fed continued to raise interest rates in 2022, the bonds that the bank owned lost significant value as they were yielding almost nothing compared to current yields. Thus, the bank was sitting on a huge chunk of unrealised losses.
Start-up funding freeze
A start-up funding freeze put pressure on the bank’s clients because companies were no longer able to raise money through fundraising or IPOs. They then began taking cash out of the bank to pay for their business expenses. SVB was compelled to sell off some of its assets at a time when their value had decreased in order to satisfy those requests.
Inflows to the bank reached an all-time low
SVB’s deposit inflows also fell as most of its clients were under a severe funding crisis and used their deposit money for their normal business operations. As a result, deposits fell from nearly $200 billion at the end of March 2022 to $173 billion at year-end 2022.
The last straw
SVB declared its intention to raise capital on March 8. Nonetheless, the announcement caused alarm among its clients as well as the stock markets. According to a filing by regulators, on March 9th, its clients sought to withdraw $42 billion in deposits—roughly a quarter of the bank’s total. Consequently, it ran out of money.
What happened next?
Over the weekend, the investors were expecting the government to intervene by either finding a potential buyer for the Bank or coming up with a bailout package as it did in the 2008 crisis.
Let us understand the plan formulated by the government to save the depositors and restore confidence in the system.
Government to the rescue:
New York-based Signature Bank had also failed and was being seized on Sunday, showing just how quickly the financial bleeding was taking place. Signature Bank is the third-largest bank failure in American history, with assets of more than $110 billion.
To avoid escalation, Treasury Secretary Janet Yellen, Federal Reserve Chair Jerome Powell, and Chairman of the Federal Deposit Insurance Corporation Martin J. Gruenberg said in a joint statement on Sunday that the FDIC will make the customers of SVB and Signature Bank whole i.e paid back in full. This included both insured and uninsured deposits.
But shareholders and holders of unsecured corporate bonds will not be protected by the regulators’ plan.
Where will the money come from for uninsured deposits?
Deposit Insurance Fund:
The cost of covering the deposits, including uninsured amounts in excess of the FDIC’s $250,000 limit, will be paid for in part out of the agency’s Deposit Insurance Fund — a reserve that is paid for by a quarterly fee on banks.
Bank Term Financing Program:
Interest rates soared at an unprecedented rate last year as the Fed tried to stop inflation. This indicates that the value of banks’ investments in ultra-low-interest Treasury bonds from a few years ago has plummeted. Thus, the Fed unveiled the Bank Term Financing Program, where the Fed said it will offer banks loans for up to a year in exchange for US Treasury bonds and mortgage-backed securities held by banks that have tumbled in value.
The lending facility will allow banks to borrow money from the Fed rather than having to sell Treasuries and other securities to raise the money, which would result in a loss, to pay depositors. The Treasury has set aside $25 billion to offset any losses incurred under the Fed’s emergency lending facility. The aim of this program is to prevent more bank runs in the future.
Will this be a repeat of the 2008 Financial Crisis?
Those who lived through the 2008 financial crisis might be experiencing a sense of déjà vu with the case of SVB.
The issue is larger than SVB
Right now, there is a general understanding that no one expects any problems to spread to the larger banking industry because SVB has a distinctive customer base- catering almost entirely to the technology sector and VC-backed enterprises. Most other banks are much more geographically, commercially, and industry-diversified.
But, most banks are dealing with unrealized marked-to-market losses on their Held To Maturity books as a result of rising interest rates, which the market will begin to price in (an estimated $620 billion in combined unrealized losses, which is more than a quarter of the $2.2 trillion in total shareholders’ funds of the industry).
SVB Financial, the owner of the SVB, continued to have an investment grade rating of A3 from Moody’s as of March 8. In the evening of that day, Moody’s downgraded SVB by just one little notch, to Baa1, after the bank announced a $1.8 billion loss on the sale of bonds, a planned capital raising, and a plethora of liquidity measures. On March 10, the bank was shut down. This raises serious questions about the worthiness and reliability of these ratings.
Effect on Small Banks
If the public is not convinced of the viability of small banks, the big banks could then see a flood of cheap deposits as panicked investors shift funds from smaller banks to bigger banks. This might put several small banks under pressure, which would ultimately harm the balance sheets of large banks.
Debate on Moral Hazard:
There are arguments against government assistance for these banks. Incentives such as the Bank Term Financing Program create a “moral hazard” and set the wrong precedent encouraging risky behaviour amongst greedy bankers on the belief that all the deposits will be insured by the government. Many believe that Banks should be held accountable for the lapse in their risk management. The regulator reaffirms that this government assistance is focused more on protecting the depositors rather than the shareholders. Yet, while these initiatives appear to offer a short-term cure to the issue, a more lasting answer is required to strengthen the system.
Effects on the Indian startup ecosystem
According to current data from market intelligence platform Tracxn, SVB had exposure to at least 21 startups in India, albeit the amount invested in these startups is unknown. It has also been reported that the vast majority of the Indian portfolio companies of technology investor Y Combinator have some degree of exposure to problematic banks. While the deposit money is now insured by the US government, the negative sentiment may worsen the already gloomy funding environment for startups in India.
The government’s efforts on Sunday were the largest since the 2008 financial crisis, but they were still very modest in comparison to what was done the last time. The two troubled banks themselves haven’t been saved, and the taxpayer’s money hasn’t been spent directly.
Although we do not observe a cascading effect on the entire banking system, this crisis does highlight the banks’ misaligned maturity investment and poor risk management. Other small banks with comparable issues would come under investor scrutiny as social media has sped up investor reaction times.
Disclaimer: Above piece is only for information purposes. Please consult a SEBI Registered Investment advisor before taking any investment decision.