The most breaking news at present which is a concern for the general health of economy is the Silicon Valley Bank collapse. The question of the hour is, how is the failure of the SVB bank going to impact? Will it result in a snow-balling effect? Will this result in another financial crisis like 2008? Lets first understand the picture so far..
Going by the description available on google, Silicon Valley Bank was a commercial bank headquartered in Santa Clara, California. SVB was the 16th-largest bank in the United States at the time of its failure on March 10, 2023, and was the largest bank by deposits in Silicon Valley. It was a subsidiary of the bank holding company SVB Financial Group.
The bank was, as any bank, involved in the business of taking deposits and giving loans. It was primarily giving out loans to Venture Capitalists and Private Equity who would then invest in Startups, or would directly engage in giving loans to Startups. If we look at the balance sheet of the bank, it was clear that it had huge deposits in the form of Non-Interest bearing Deposits, like Current Account. It wouldn’t be wrong to assume that when the bank gave out money to Startups, directly or indirectly through VC or PE, they had to put their money somewhere, and so they kept their excess money as Non-Interest Bearing on Demand ( much like Current Account in India) with SVB.
What started the collapse
One of the problems that started this entire episode which resulted in the failure was the Asset class mismatch. The cash that SVB had was used by the bank to invest in lone term US Treasury Bonds. A major chunk of the cash deposit which the depositors could encash on demand, was locked in long term investments by the Bank.
It would also be important to shed some light on the Bond Yield here. Bond Yield is the return an investor earns on Bonds, in the form of Coupons and maturity or sale proceeds. Before the Federal Reserve started hiking interest rate in order to control inflation, the Bond Yield was low. However, in the recent 2 years approximately, the bond yields have increased. In case our readers many not know, Bond yield and bond prices share an Inverse Relationship. Meaning that when the bond yield rises, it results in the fall of Bond prices. SVB in the recent past had utilised the deposits it had to invest in Long term bonds. When the Bond Yields started to rise, the unrealised losses of the bank started to rise since the Bond prices were falling. Where in one hand, rate of interest was rising, the cost of borrowing was rising, the bond yields were rising, a major block of funds was locked in a comparatively low yield security, thereby widening losses.
Another issue that worsened the situation for SVB was run on the bank. Most of the depositors started to take out their deposits with the bank in order to safeguard themselves. SVB did not have that kind of liquidity. It was difficult for them to process the request, and to cover the losses they incurred due to yield rise they decided to raise funds. They failed to raise the funds.
The company shares took the hit. The shares fell down more than 60% in just 2 days. The Federal Deposit Insurance Corp, stepped in to take control of the matter. A new entity was created. All the deposits of SVB was then transferred to this new entity, the Deposit InsuranceBank of Santa Clara.
Let us also understand, the failure of SVB has majorly impacted the financial health of the economy and created a scary situation for many start-ups which had their money deposited into the bank.
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The SVB situation is still unfolding. We hope everything gets under control, and that nothing like the 2008 crises repeats.