The Collapse of Silicon Valley Bank

The failure of SVB was the second-largest bank failure in American history, behind that of Washington Mutual in 2008. Even though bank failures are regular, it is exceptional for banks the size of SVB to go bankrupt. When these uncommon incidents have place, concerns regarding how they can be avoided arise.

Welcome to the Saral Finance Newsletter where we talk all about finance in a most simplest way. So today let us deep dive into how the Silicon Valley Bank collapsed.

Introduction to the Silicon Value Bank

The Silicon Valley Bank was established in 1983 in Santa Clara, California. During the initial years of its establishment bank was heavily investing in the real estate property business. In that decade about 50% of the investments of the bank were in real estate business.

But as per the basic rule of finance, diversification is the name of the game when it comes to building a resilient investment portfolio. If you are putting all or majority of your eggs in one basket then that is a high-risk portfolio. As the portfolio of the bank was risky in 1992 California's real estate market crashed causing $ 2.2 million in losses to that bank. Post these losses banks diversified the portfolio into various other asset classes.

Rise of The Silicon Valley Bank

Now coming to a decade of 2000, the bank invested heavily in technology-based start-ups. By 2015, the bank had become so big that it had invested in around 50-60% of technology startups in the US at that time. So, if we consider during 2015 also bank repeated the same mistake of investing a major part of their portfolio in technology-based startups.

By the year 2022, the bank became the 16th biggest lender in America holding a total assets value of $200 billion. Till this time everything was going as per the bank.

The Silence before the storm

But coming back to the year 2021 when the Covid pandemic happened and was the situation of complete lockdown around the world. All the investors thought that it was the best time to invest in technology & and software-based companies as they would be most profitable during this period of lockdown.

This was the reason that during the time of the pandemic, many startups all around got funding. Even in US markets, Startups raised around $300 billion which was almost double the amount raised in the year 2020. The startups were flooded with the investor's money and the Silicon Valley bank was the preference for these startups so they deposited their major chunks in the bank. And due to this in March 2021, the total value of Bank deposits almost doubled to $124 billion from last year's $62 billion.

When any bank gets money from its customers it can do various things from that money like give that money as a loan to other banks, or corporations or invest that money in some assets. The SVB did the same they invested their money in government and corporate bonds. However, they invested in bonds when the interest rates were around 0%-0.25%.

Beginning of the Collapse

During the Pandemic, the government increased the interest rates for the purpose of economic easing in the economy. And there is an inverse relationship between bond prices and interest rates that is if the interest rates in the markets increase the value of the bond in your holding will decrease and vice versa. This was the first major difficulty faced by the bank.

As the interest rates were increased the startups that have raised funding through loans from the market cost of interest were also increasing and they were not getting any additional funding from venture capitalists to run their startups. So, the startups started withdrawing their surplus money from SVB but due to this panic withdrawal from startups and other customer banks was not holding enough liquidity.

The Domino effect

Seeing the Panic in the market banks started liquidating their bond positions on huge losses. In March 2023, the bank sold around $ 21 billion bonds incurring a loss of $ 1.8 billion on them. When the news was out the bank share almost plunged by 55-60% in the stock markets.

Now the question comes what really happened to the money of the customers when the bank collapsed?

In the US, whenever any bank collapses the government has set a limit of $ 250k as the amount that the customer will receive from the bank for the deposits that it has made. The FDIC took control of the bank and incorporated a new bank called Deposit Insurance National Bank of Santa Clara.

When the bank crashed around 89% of its deposits were uninsured. The US government said It will ensure all SVB account holders will be able to retrieve any funds they have when they start day-to-day statements.

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