By William Chittenden*
Silicon Valley Bank, which catered to the tech industry for three decades, collapsed on March 10, 2023, after the Santa Clara, California-based lender suffered from an old-fashioned bank run. State regulators seized the bank and made the Federal Deposit Insurance Corporation its receiver.
SVB, as it’s known, was the biggest U.S. lender to fail since the 2008 global financial crisis – and the second-biggest ever.
We asked William Chittenden, associate professor of finance at Texas State University, to explain what happened and whether Americans should be worried about the safety of their financial system.
Why did Silicon Valley Bank collapse so suddenly?
The short answer is that SVB did not have enough cash to pay depositors so the regulators closed the bank.
The longer answer begins during in the pandemic, when SVB and many other banks were raking in more deposits than they could lend out to borrowers. In 2021, deposits at SVB doubled.
But they had to do something with all that money. So, what they could not lend out, they invested in ultra-safe U.S. Treasury securities. The problem is the rapid increase in interest rates in 2022 and 2023 caused the value of these securities to plunge. A characteristic of bonds and similar securities is that when yields or interest rates go up, prices go down, and vice versa.
The bank recently said it took a US$1.8 billion hit on the sale of some of those securities and they were unable to raise capital to offset the loss as their stock began dropping. That prompted prominent venture capital firms to advise the companies they invest in to pull their business from Silicon Valley Bank. This had a snowball effect that led a growing number of SVB depositors to withdraw their money too.
The investment losses, coupled with the withdrawals, were so large that regulators had no choice but to step in to shut the bank down to protect depositors.
Are the deposits now safe?
From a practical perspective, the FDIC is now running the bank.
It is typical for the FDIC to shut a bank down on a Friday and have the bank reopen the following Monday. In this case, the FDIC has already announced that the bank will reopen on March 13 as the Deposit Insurance National Bank of Santa Clara.
At the end of 2022, SVB had $175.4 billion in deposits. It’s not clear how much of those deposits remain with the bank and how much of those are insured and 100% safe.
For depositors with $250,000 or less in cash at SVB, the FDIC said that customers will have access to all of their money when the bank reopens.
For those with uninsured deposits at SVB – basically anything above the FDIC limit of $250,000 – they may or may not receive back the rest of their money. These depositors will be given a “Receiver’s Certificate” by the FDIC for the uninsured amount of their deposits. The FDIC has already said it will pay some of the uninsured deposits by next week, with additional payments possible as the regulator liquidates SVB’s assets. But if SVB’s investments have to be sold at a significant loss, uninsured depositors may not get any additional payment.
What was the last US bank to fail?
Prior to the failure of SVB, the most recent bank failures occurred in October 2020, when both Almena State Bank in Kansas and First City Bank of Florida were taken over by the FDIC.
Both of these banks were relatively small – with about $200 million in deposits combined.
SVB was the biggest bank to fail since September 2008, when Washington Mutual failed with $307 billion in assets. WaMu fell in the wake of investment bank Lehman Brothers’ collapse, which nearly took down the global financial system.
On the whole, U.S. bank failures aren’t all that common. For example, there were none in 2021 and 2022.
Is there any risk that more banks might fail?
At the end of 2022, SVB was the 16th-largest bank in the United States with $209 billion in assets.
That sounds like a lot – and it is – but that’s just 0.91% of all banking assets in the U.S. There is little risk that SVB’s failure will spill over to other banks.
Having said that, SVB’s collapse does highlight the risk that many banks have in their investment portfolios. If interest rates continue to rise, and the Federal Reserve has indicated that they will, the value of the investment portfolios of banks across the U.S. will continue to go down.
While these losses are just on paper - meaning they’re not realized until the assets are sold – they still can increase a bank’s overall risk. How much the risk will go up will vary from bank to bank.
The good news is that most banks currently have enough capital to absorb these losses – however large – in part because of efforts taken by the Fed after the 2008 financial crisis to ensure financial firms can weather any storm.
So rest easy for now, the U.S. banking system is sound.
*William Chittenden, Associate Professor of Finance, Texas State University. This article is republished from The Conversation under a Creative Commons license. Read the original article.
29 Comments
While the Government hopes the deposit guarantee scheme will be in place by early 2024, banks want things to go more slowly.
Deposit guarantee scheme in place for 2024? Don't bet on it. | Stuff.co.nz
Right now the process to fix a failed NZ bank is Open Banking Resolution,(where some of depositor funds can be haircut to refund the bank). The Statutory manager may define a de minimis to be applied, below which transactional accounts would not be haircut.
After the haircut the bank reopens with a NZ gurantee under stat managenement....... ie you cannot be haircut twice. So there is no point once reopened in running to another bank (as you might be in for another cut over there....).
This would all only happened if the group parent failed to stump up the required funding, or indeed lead to it via failure in Aussie.
There's a detailed look at NZ's incoming deposit insurance regime here - https://www.interest.co.nz/personal-finance/117092/what-nzs-deposit-insurance-regime-will-look-and-what-itll-mean-depositors
And detail on the open bank resolution (OBR) policy here https://www.interest.co.nz/personal-finance/118892/rbnz-review-open-bank-resolution-policy-settings-once-depositor
It overly invested in a speculative asset class for depositors looking any form of return due to the debasement of currency by central banks. Then the tide went out. Janet Yellen quoted as saying "no bailout"...time will tell.
Will this be the "jenga moment" on speculation not supported by income....?
Yes, but they are super sensitive to bale out perception since 2008 was so recent. Last I heard they plan on baling out depositors (not the institutions) funded by a levy on the banking sector. Of course, that means the banks will have less to pay interest to depositors or shareholders, so it's still socialisation. Pick your losers, but there must be losers for those previously unrealised losses now in everyone's face.
Failure of ALM at the Bank. Wonder how competent were the CFO and his Team at SVB. The Board also has to take a share of the blame for poor governance. When major investment decisions were taken, did they assess the risks fully ?
It would be enlightening to learn how Banks operate and take such decisions. Is it a collective or individual division chief ? What is the role of CEO and COO ?
I learnt that they also did not have a Chief Risk Officer since 4/2022. A criminal gap in governance.
Some one should do a thorough study and publish a book, highlighting the good and bad practices at Banks in that level.
Anyways, Biden/Yellen have opened the Rescue Purse, with the usual stricture that the culprits will be punished. Fat chance of that happening.
Translation: the Fed's hiking cycle is dead and buried, and here comes the next round of massive liquidity injections. It also means that the Fed, Treasury and FDIC have just experienced the most devastating humiliation in recent history - just 4 days ago Powell was telling Congress he could hike 50bps and here we are now using taxpayer funds to bail out banks that have collapsed because they couldn't even handle 4.75% and somehow the Fed has no idea! Link
The whole system is f#%>ed and very few seem to understand. Maybe economists understand it but don’t state it, but who knows with those clowns.
Hike interest rates too much and your economy falls apart because it is so debt dependent. Don’t hike interest rates enough and your economy is destroyed by inflation.
Talk about a wicked, wicked problem.
But it’s a problem of the central banks’ own making.
There’s simply no pain-free way out.
Engineering Recession has the unintended consequence of Bank failures.
Also to be considered is how far the Federal Reserve and the Treasury assess their macro policies like interest rate shifts, given the sizeable bond portfolio held by various stakeholders. Not just interest rates, but other tools used by the Fed.
SVB was a key source of financing for smaller venture and private equity firms. More than half of the bank’s $73.6 billion loan portfolio comprised fund financing, according to SVB’s most recent annual report. That came primarily in the form of subscription credit lines that funds could draw on to ease capital calls. I.E. they lent money to people who could not pay it back or refinance the debt when rates went from 2% to 7% in 2 years. Some of the deposits they took in they invested in MBS in 2020-2021 . But because of those same rate rises and yield destruction of the MBS. Those MBS had to be sold at a 30% discount when they needed liquidity to pay back depositors.
Classic case of poor asset-liability management. And not the first time a bank has come undone because of this.
And now all depositors getting bailed out but apparently not at the cost of the US taxpayer. Must be enough equity value to do this (i.e. solvent once unsecured bondholders are bailed in).
Ah, there it is. Socialise the losses....The BTFP.
To support American businesses and households, the Federal Reserve Board on Sunday announced it will make available additional funding to eligible depository institutions to help assure banks have the ability to meet the needs of all their depositors. This action will bolster the capacity of the banking system to safeguard deposits and ensure the ongoing provision of money and credit to the economy. The Federal Reserve is prepared to address any liquidity pressures that may arise.
There is an accounting rule that if an institution intends to hold an instrument like a bond to maturity, they do not need to recognise any unrealised loses as the bond price falls, so long as they don't sell the bond. And here we are, with realised loses all in a big "surprising" surge.
Our banks added 50 billion to their collective mortgage books 2020-2021. For many of those properties. If they absolutely had to be sold today. They would fetch less than the amount of the mortgage owed on them. The banks know this. The borrowers know this. They don't mark to market the value of your home every year and request additional capital to keep you within the acceptable limits. They don't even have to reassess you for LVR %. Extend and pretend and hope that conditions will return at some stage in the future to allow the property market to be reflated.
Lending for Homes is not like Lending against stocks and paper securities. The former are assessed primarily by servicing terms over a longer period and LVR is kept at reasonable levels, taking into account the borrower's stake in the purchase. So, as long as income of the borrower is used to service the loan, principal and interest, Banks are not going to worry. There is no system of recalculating LVR every year. That would throw a huge wrench into everyone's calculations for long term home ownership, which is a benefit to society.
Commercial and Business lending also is fairly a longer term relationship, with bumps negotiated cautiously.
Margin calls on lending against stocks and paper securities is a different beast. Agility is the key
This is a fantastic way to explain stuff to every one who is not in Banking.
Lender of the Last Resort and Lender of the One beofre Last Resort. The evolution in Banking. Does it mean the Central Banks are not agile or Others can replace Central Banks in some respects.
Looks like the Fed+Yellen plan to spread the loss across the banks with a levy, because it has been long enough since 2008 to remember they dragged everyone in for those baleouts. I count this as another can-kick. The lesson to be learned is about speculation and risk, but instead the guilty parties will learn that they can rely on their industry mates who have been feeding at the money creation trough to help out when good times turn to bad.
It's really a game of sharing loss of paper wealth, and there is a lot of it to be shared.
Who has made lots of paper wealth gains over recent years and could be a good target to shoulder some of the burden?
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