Why did Silicon Valley bank fail and is the next financial crisis? | banks

The collapse of the Silicon Valley Bank (SVB) sent shock waves through financial and technical circles.

US regulators on Friday seized the assets of a Santa Clara, California-based bank after depositors began withdrawing money en masse amid concerns about the lender’s financial condition.

Since then, financial regulators around the world have raced to contain the fallout from the collapse of SVB Bank, the largest banking failure in the United States since 2008, and to boost confidence in the global financial system.

Why did the SVB collapse?

As the SVB name suggests, the bank’s business has been largely geared towards US technology startups. During the COVID-19 pandemic, the lender has seen an influx of deposits as tech companies made a roaring trade catering to people stuck in their homes.

SVB has invested a lot of this money in US government bonds – traditionally one of the safest types of investment.

The SVB’s troubles began when the US Federal Reserve began raising interest rates last year in response to rising inflation, causing the value of these bonds to plummet.

As the economic conditions of the tech sector become more tense in the wake of the pandemic boom, many SVB clients are beginning to rely on their cash to stay afloat. Faced with a lack of liquidity, SVB was forced to sell its bonds at significant losses, raising concerns about its financial health.

Within 48 hours, terrified depositors had withdrawn enough money to cause the bank to collapse.

“SVB collapsed because of a stupid rookie mistake in managing interest rate risk: They invested short-term deposits in long-term bonds. When interest rates went up, the value of bonds went down, which made the bonds go down,” James Angel, an expert in regulating global financial markets at Georgetown University, told Al Jazeera. It led to the elimination of the bank’s equity.

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This is the same phenomenon that wiped out the American savings and loan industry in the 1980s. Some people never learn.”

Campbell R Harvey, a professor at Duke University’s Fuqua School of Business, said SVB’s problems were a lesson in the need for banks to diversify their assets.

“They seem to cater to a certain clientele, and we all know technology takes a hit — and if you’re not diversified, you take a hit, too,” Harvey told Al Jazeera.

“Your loan book needs to be diversified,” Harvey added. “It’s not clear that this bank has actually done that.”

What are the repercussions of SVB’s collapse so far?

Two days after the collapse of SVB, US regulators seized the assets of Signature Bank, a New York-based bank known for its work with the cryptocurrency sector, marking the third largest banking failure in US history.

In an effort to stem the fallout, US regulators announced Sunday that they will underwrite all deposits at both lenders.

The Fed also unveiled a lending program, the Bank Term Financing Program (BTFP), which aims to boost confidence in the financial system by giving banks the option to borrow directly from the Fed to avoid having to rely on money-making bond sales.

US President Joe Biden sought to reassure the public that the situation was contained, saying, “Americans can have confidence that the banking system is secure.”

However, banking stocks, including those of the US “big four” – JPMorgan Chase, Bank of America, Wells Fargo and Citibank – fell sharply amid fears of contagion through the financial sector.

First Republic Bank, a mid-tier bank based in San Francisco, California, has seen its share price drop as much as 60 percent.

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Banking stocks in Europe and Asia also took a big hit.

In the United Kingdom, financial authorities announced that they had facilitated the sale of the domestic SVB unit to HSBC, Europe’s largest bank, in order to protect 6.7 billion pounds ($8.1 billion) in deposits.

Canadian regulators announced that they had temporarily taken control of the country’s SVB unit, while Germany’s federal financial watchdog said it had temporarily closed the local branch of the lender.

How important is SVB in the banking industry?

SVB was the 16th-largest bank in the United States, and has been described as a mid-tier lender rather than one of the major players.

“It’s an unusual bank in that it’s not a big bank, though it’s huge,” Harvey said.

As of December, the lender had $209.0 billion in assets and $175.4 billion in total deposits, according to the Federal Deposit Insurance Corporation.

By comparison, JPMorgan Chase, the largest bank in the US, had $3.67 trillion in assets last year.

However, SVB has had a significant impact in the tech ecosystem, earning a reputation for supporting startups that large institutions deemed too risky to lend to.

The SVB failure reportedly left some tech CEOs scrambling to change banks and explore options to pay employees amid fears they would not have access to their money.

Although SVB customer deposits are ultimately guaranteed, the full impact of the lender’s implosion on the startup landscape may not be apparent for some time.

Could the collapse of SVB cause a financial crisis like 2007-2008?

While the fallout from the SVB’s collapse lingers, economists widely agree that its failure is markedly different from the collapse of financial institutions, such as Bear Stearns and Lehman Brothers, that precipitated the 2007-2008 global financial crisis.

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In contrast to institutions such as Lehman Brothers, SVB’s business has been concentrated in one sector and has relatively few dealings with other banks.

“The SVB situation certainly has people worried, but I don’t think it’s likely to turn into a Lehman type of situation, especially given how aggressively the Fed has intervened, including by promising to protect even uninsured deposits,” David Schell, Professor Corporate Law at the University of Pennsylvania Law School of the Island.

“I think any immediate repercussions are likely to become clear very quickly, although it is certainly possible that there are other banks in a similar predicament due to higher interest rates.”

Financial regulation has also been significantly tightened since the 2007-2008 crisis.

“Fortunately, the increased capital requirements that were imposed after the 2008 crisis seem to be paying off,” Angel said.

“Banks are now required to have much more capital than before, which makes them much less risky. Even banks that have made stupid mistakes mostly lose their money and not their depositors’ money.”

William T Chittenden, assistant professor of finance and economics at Texas State University, said he believes infections from SVB will be limited.

“With BTFP, banks will be able to borrow against those securities at face value, allowing banks to avoid selling them at a loss. This would give banks the liquidity they need to meet any unexpected demand for liquidity from depositors,” Chittenden told Al Jazeera.

He added, “We will know if this works or if there are widespread fallout from the SVB failure in the next few days.” “The vast majority of banks in the US are financially sound and with the new BTFP system, depositors should feel at ease.”

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