My thoughts on Silicon Valley Bank’s failure, the largest banking disaster since the 2008 Financial Crisis.
Let us summarize in simple terms.
The bank earned renown in California as the banker to private equity and venture capital firms, specialized in “tech and healthcare”.
How does the banking industry operate, and what causes a bank to fail?
A bank accepts cash deposits from its customers (liabilities for the bank), and the bank makes money by lending or investing that cash. The income generated by the bank is its asset.
When a depositor gives a bank $100, the bank receives a loan.
The banks take that $100 and can either: a. loan it out or b. invest it.
Whatever it does (a) or (b), it must generate more cash than it pays back to depositors.
As a result, a bank is likely to fail if it cannot earn a sufficient return (cash) on its loans or investments that is greater than the interest rate paid to depositors.
SVB stashed $91 billion in long-term deposits in 2021 and invested in mortgage and US Treasury bonds, which are now worth $15 billion. According to another story, the bank liquidated nearly all of its available-for-sale securities ($21 billion) for a $1.8 billion loss.
What caused the devaluation? — Since 2022, the central bank has aggressively raised interest rates to curb excessive inflation. To cool the economy, it increased the cost of borrowing for businesses and consumers. While interest rates were approaching historical lows, banks piled into long-dated, low-risk Treasuries. But, as interest rates rose, the value of those assets fell, leaving them with unrealized losses.
To be honest, no one could have predicted this outcome when the investment was made, proving that no investment is without risks.
What’s the big deal about this? —
A bank is supposed to maintain some of its deposits in reserves with the apex bank (called cash reserves) and do whatever they want with the balance (often lend and trade) under a fractional reserve banking system (which also applies in Nigeria). As easy as ABC
It’s starting to get interesting around here! —
The United States now has a no-reserve banking system with a 0% cash reserve, which means that if you deposit $100, a bank can do whatever they want with the entire $100. They began this in April 2020 around the COVID period, I believe, to stimulate growth in the American economy.
Meanwhile, the FDIC can only insure $250k per depositor, and according to the most recent filing, only 5% of the bank’s deposits were even insured.
As a result, this will have an impact on client cash flow. To be more specific, start-ups, tech companies and healthcare companies in the US and by extension, companies in other part of the world.
Why is it likely that SVB will not survive? —
The US Federal Reserve has decided to stop bailing out firms (I think in 2007). AIG was about to collapse less than a week after Lehman Brothers failed in 2008, and the Fed had no choice but to intervene.
Bush did not assist Lehman Brothers in 2008, but he did assist AIG because if AIG failed, the entire economy would collapse. Because AIG insures 80% of large enterprises.
Based on this, I doubt Biden will be of assistance.
Anyone who believes that preventing bank failures and panics isn’t a federal responsibility has missed a couple hundred years of financial history. It’s known as systemic risk, and it can only be stopped by federal banking authorities.
Causes of SVB bankruptcy
1 — Risk
2 — Overconfidence
3 — Culture
4 — Regulator inaction
Where is Joe Biden? What happened to Powell? Yellen, where are you? They must put an end to this problem immediately. Declare that all depositors are safe. Put SVB in the Top 4 banks. If you don’t do it today, Monday, the crisis will spread.
This would solve the problem!
The above was drafted over the weekend but I couldn’t post due to some personal reasons
However, the US authorities announced last night that all depositors are protected and would have access to their cash as from today, despite that the deposits were not insured.
Also, the UK branch of SVB has been taken over by HSBC.
This is a great one and goes with my suggestions
What are your thoughts?