The collapse of the Silicon Valley Bank (SVB) has sent shockwaves through financial and tech circles.
On Friday, US regulators seized the assets of the Santa Clara, California-based bank after depositors began withdrawing money in droves fearing the lender’s financial health.
Since then, financial regulators around the world have raced to contain the fallout from the collapse of the SVB, the largest US bank failure since 2008, and bolster confidence in the global financial system.
Why did the SVB collapse?
As SVB’s name suggests, the bank’s activities were heavily focused on US tech startups. During the COVID-19 pandemic, the lender saw an influx of deposits as tech companies made a roaring trade in catering to people stuck at home.
SVB invested a large part of this money in US government bonds, traditionally one of the safest types of investments.
SVB’s troubles began when the US Federal Reserve began raising interest rates last year in response to skyrocketing inflation, causing the value of those bonds to plummet.
As economic conditions for the technology sector became more difficult following the pandemic boom, many of SVB’s clients began to use their money to stay afloat. Faced with a cash shortage, SVB was forced to sell its bonds at large losses, raising concerns about its financial health.
Within 48 hours, startled depositors had withdrawn enough money to cause the bank to collapse.
“SVB collapsed because of a stupid rookie mistake with their interest rate risk management: they invested short-term deposits in long-term bonds. As interest rates rose, the value of the bonds fell, wiping out the bank’s equity,” James Angel, an expert on global financial markets regulation at Georgetown University, told Al Jazeera.
“This is the same phenomenon that wiped out the American savings and loan industry in the 1980s. Some people never learn.”
Campbell R Harvey, a professor at Duke University’s Fuqua School of Business, said the SVB’s woes were a lesson in the need for banks to diversify their assets.
“It seems like it was aimed at a certain customer base, and we all know that technology took a hit — and if you’re not diversified, you’re going to take the hit,” Harvey told Al Jazeera.
“Your loan portfolio needs to be diversified,” Harvey added. “It is not clear that this bank actually did this.”
What are the consequences of the collapse of the SVB so far?
Two days after the collapse of SVB, US regulators seized the assets of Signature Bank, a New York-based lender known for its dealings with the cryptocurrency sector, marking the third-largest bank failure in US history .
In an effort to contain the fallout, US regulators announced on Sunday that they would guarantee all deposits with both lenders.
The Federal Reserve also unveiled a lending program, the Bank Term Funding Program (BTFP), which aims to bolster confidence in the financial system by allowing banks to borrow directly from the Fed to avoid relying on loss-making bond sales.
US President Joe Biden has tried to reassure the public that the situation is under control, saying, “Americans can trust that the banking system is safe.”
Nevertheless, bank stocks, including those of the US “big four” – JPMorgan Chase, Bank of America, Wells Fargo and Citibank – have fallen sharply on fears of contagion in the financial sector.
First Republic Bank, a mid-tier bank based in San Francisco, California, saw its share price fall by as much as 60 percent.
Banking stocks in Europe and Asia also took a big hit.
In the United Kingdom, financial authorities announced they had facilitated the sale of SVB’s local unit to HSBC, Europe’s largest bank, to secure £6.7 billion ($8.1 billion) in deposits.
Canadian regulators announced they had temporarily taken control of the country’s SVB unit, while Germany’s Federal Financial Supervisory Authority said it had provisionally closed the lender’s local branch.
How important was SVB for the banking industry?
SVB was the 16th largest bank in the US and is described as a mid-sized lender rather than one of the major players.
“It’s an unusual bank because it’s not one of the big banks, although it’s substantial,” Harvey said.
As of December, the lender had $209.0 billion in assets and $175.4 billion in total deposits, according to the Federal Deposit Insurance Corporation.
By comparison, JPMorgan Chase, the largest bank in the US, had assets worth $3.67 trillion last year.
However, SVB had an outsized influence in the tech ecosystem, gaining a reputation for supporting startups that larger institutions considered too risky to lend to.
The failure of the SVB reportedly caused some tech executives to rush to switch banks and explore options to pay staff, fearing they would not be able to access their funds.
While SVB’s clients eventually had their deposits guaranteed, the full effect of the lender’s implosion on the startup scene may not be apparent for some time.
Can the collapse of the SVB trigger a financial crisis like in 2007-2008?
While the effects of the SVB’s collapse are still visible, economists broadly agree that its failure is markedly different from the implosion of financial institutions, such as Bear Stearns and Lehman Brothers, that sparked the 2007 global financial crisis. -2008 caused.
Unlike institutions such as Lehman Brothers, SVB’s activities were concentrated in one sector and had relatively few contacts with other banks.
“The SVB situation certainly worries people, but I don’t think it’s likely to turn into a Lehman-like situation, especially given how aggressively the Fed has intervened, including promising to protect even uninsured deposits,” says David Skeel, a corporate law professor at the University of Pennsylvania Law School, told Al Jazeera.
“I think any immediate consequences will become apparent fairly quickly, although it is certainly possible that there are other banks that are in a similar situation due to the rise in interest rates.”
Financial regulations have also tightened considerably since the crisis of 2007-2008.
“Fortunately, the increased capital requirements imposed after the 2008 crisis appear to be paying off,” said Angel.
“Banks now have to have much more capital than before, which makes them much less risky. Even the banks that have made stupid mistakes usually lose their own money and not that of depositors.”
William T Chittenden, an associate professor of finance and economics at Texas State University, said he believes contagion from SVB will be limited.
“The BTFP allows banks to borrow against those securities at face value, helping banks avoid selling them at a loss. This should give banks the liquidity they need to meet the unexpected demand for cash from their depositors,” Chittenden told Al Jazeera.
“We will know in the coming days if this works or if there are widespread consequences of the failure of the SVB,” he added. “The vast majority of banks in the US are financially sound and with the new BTFP savers should feel comfortable.”