Silicon Valley Bank: What went wrong?

High inflation and rising interest rates have been the key concerns for investors, until the news from the banking sector came to fore – adding another set of worries for all. On Wednesday 8th March 2023, Silicon Valley Bank (SVB) announced it needed to raise over $2 billion to shore up its balance sheet. This was taken as a negative event by the SVB stakeholders, raising concerns on why the bank needs to raise funds.

SVB was known as the banker for Venture Capitalists (VC funds) and technology start-ups. The bank was serving to this engine of US technology boom and innovation since more than four decades. More than 97% of SVB’s depositors base was those with over $250,000 deposits, the Federal Deposit Insurance Corp.’s (FDIC) $250,000 insurance limit. The bank had over $150 billion of uninsured deposits at the close of last year.

During last few years, particularly at the time of Covid-19 pandemic, the bank parked most of the deposits in safe-haven investment securities like government bonds (US Treasuries) and government backed mortgage securities. However, the tables turned when the Fed started increasing interest rates in response to 40-year high inflation and rising cost of living crisis. This induced fixed income bonds to start losing values as bonds’ values drop when interest rates rise. The bank had unrealised losses of over $17 billion on those securities at the end of last year.

Those losses were unrealised and there was no issue at all if the bank could hold on to those assets until their maturity to get the full invested capital back. To do that, bank needed a sufficient liquidity to meet withdrawal requests. However, the bank did not have that kind of liquidity as the depositors were VCs and tech firms, who withdrew in heavy amounts compared to retail community. The bank sold some of those bonds at a loss of $1.8 billion to meet liquidity needs. Then, SVB announced the bank needs to raise $2.25 billion from equity investors to boost its balance sheet.

The panic spread in less than 48 hours that resulted the bank closure in just two days through regulator intervention. There was a bank run after the news that bank is going to raise over $2 billion through equity issuance. A flood of $42 billion withdrawal requests in less than 48 hours raised serious concerns in the investment community and the stock price plummeted over 60% in response to that panic.

A contagion effect emerged after the panic and few other banks felt the pain as well. Signature bank is another example that faced similar bank run phenomenon and hence the regulator closed the bank on 12th March 2023. The First Republic Bank and many other banks’ stock prices started plunging as the investment community became vary of potential financial stability and resulting systemic risks.

The regulators stepped in and took over the control of both banks (SVB and Signature bank). The failure of SVB is first largest bank failure since Global Financial Crisis (GFC) of 2008 and the second largest ever after the Washington Mutual Bank in September 2008. The Signature bank is the third largest bank failure in the US banking history. To calm down the panic among depositors and to avoid further bank runs, FDIC said that all depositors (not only insured with $250,000) are protected with their full deposits.

FDIC, initially said that all depositors, including uninsured ones, would receive a dividend, and then receivership certificates for the balances that could be paid out over time, making it bit uncertain for the uninsured depositors to receive their deposits in full. However, a couple of days later, the federal agencies (FDIC, Treasury department, Fed, and President Biden) announced the “systemic risk exception” to pay-out all depositors of SVB and Signature bank in full, starting from next day, the Monday 13th 2023. The Fed also announced a “Bank Term Funding Program” to facilitate all banks to get up to $25 billion against Treasury bonds as collateral to fund their liquidity requirements. These developments from the federal agencies helped to calm down the markets, at least temporarily. How it plays out in coming months is unclear and difficult to predict.

The First Republic bank got a lifeline of up to $70 billion unused credit facility from the larger banks including the Fed, JP Morgan, and others, in addition to $25 billion Bank term Funding Program facility. The second largest Swiss bank, Credit Suisse, faced similar contagion effects recently when its largest shareholder, the Saudi National Bank, refused to provide any further credit support due to regulatory rules as it already holds 9.9% of Credit Suisse and capital requirements often prevent banks to own more than 10% of other banks. Credit Suisse stock price started plunged more than 24%, however, it received a timely relief when the bank announced that they have secured a credit facility of over $50 billion from the Swiss National Bank. That news resulted its share price to recover along with share prices of many other banks.

Now, the central bankers are challenged by two extremely important matters, one is that of higher than usual inflation and the other is that of financial stability as witnessed by the recent bank runs and two bank failures. Focusing on the one could put the other at risk. As noted in our January 2023 article (https://simplyethical.com/blog/2023-a-challenging-year-ahead), difficult economic conditions can have an impact on the banking sector and thereby on financial stability.

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