INSISDE THE COLLAPSE OF SILICON VALLEY BANK
The challenge of analyzing bank safety is that a severe loss of
confidence can actually cause an otherwise functioning financial
institution to come under duress. The recent bank crisis stemmed from
the loss of confidence in the banking system following the sudden
collapse and seizure of Silicon Valley Bank (SVB) by the FDIC on March
10.
The bank held billions of dollars worth of Treasuries and other bonds,
which is typical for most banks as they are considered safe investments.
The majority of its customers were start-ups and other tech-driven
businesses that needed more cash in the past year, so they began
withdrawing their deposits. In today's higher interest rate environment,
the value of previously issued bonds has begun to decline as they pay
lower interest rates than comparable bonds issued in the past. As a
consequence, the bank was forced to sell a significant portion of its
bonds at a steep loss, and the pace of withdrawals accelerated.
SVB was unique in some ways but also did some pretty normal bank
activities. The business of banking involves investing in assets that are a
little bit longer-term and a little bit riskier than the liabilities used to fund
these investments. Banks invest in assets such as US Treasury bonds,
mortgages, and corporate loans. The liability side of their portfolio is a
combination of checking and savings deposits, CDs, and debt.
Banks are fundamentally fragile, and as such, prone to self-fulfilling
prophecies. Despite the fact that deposit insurance has been effective in
reducing deposit runs, once confidence in banks is eroded, they are
likely to experience revolving credit runs and market funding runs. In this
case, deposits appear to have added, rather than hedged, value-based
interest rate exposure. There have been many instances of deposits
being run in the US during the 2008 financial crisis that might seem like
a thing of the past.
The bank run was devastating for SVB. SVB was forced to issue a large
amount of equity, which brought attention to their situation. It is now very
important for all banks to pay attention to the current situation. Due to
the common interest rate exposure across banks, there should be some
drop in the value of bank equity.
The tale of Silicon Valley Bank is one of ambition and management
mistakes, of a chief executive who talked so much about innovation and
the future that he and his lieutenants didn’t pay enough attention to the
mundane but enormously important work of managing risk and ensuring
financial prudence. When the bank was caught flat-footed in a rapidly
changing economic environment, it waited until the last minute to avert
its fate.
