The banking system of the United States is once again under pressure with the collapse of Silicon Valley Bank and Signature Bank. The spurring of the interest rates by the Fed with all its broad implications has in a way ended the age of easy money, the post Covid reality which had thus come into existence. The largest bank failure since the 2008 financial crisis which had then shaken the global system as a whole it also highlights the larger issues that plague the system and thus directly concerns people’s lives. The complex system of the banking industry both national and international with its set of implications, and the interconnections involved in its making, makes the whole problem multifaceted. The tech industry has already been in a place where it is seeing constant layoffs and this incident of bankruptcy has cornered it further because of what SVB’s relationship with the technology industry was. So this thing has many implications, we will analyse today the reason for the bank’s demise and also what lays ahead for this sector and the various connected sectors and eventually the economy, national and global.
Silicon Valley Bank and The Issue thereof
Based in Santa Clara this bank was ranked as the 16th biggest in the US at the end of last year and had almost $209 billion in assets. The largest bank failure since the 2008 financial crisis that saw banks such as Lehman’s Brothers and Washington Mutual turn to dust along with many others.
The initial market shock of Covid-19 in early 2020 quickly gave way to a golden period of startups and the established Technology companies. What is known for sure is that the bank had an enormous number of clients which were of or related to the technology industry especially the startups. The cash supplied by the bank was used by the industry for making payrolls and other business expenses, thus leading to an influx of deposits and post 2020 the bank’s deposits tripled in size.
This entire edifice that hence developed in the post Covid reality for the bank operated in a sense in the age of easy money. A lot of startups benefited immensely. Things started to go downhill when the Fed (America’s central banking authority) started hiking the interest rates in order to battle inflation. Inflation is a phenomenon where the prices of general commodities begin to rise. This can happen due to an oversupply of money which is what happened in this case, money starts to lose its value and then other things start to happen. The post Covid reality was all this. This has several implications. There is less appetite for risks when money becomes expensive and loans are not easily available in these conditions.
The investors of the technology related companies and the startups which formed the major parts of its clientele thus became more risk averse. At the same time a sense of insecurity and general uncertainty started to prevail in the startup industry which as we know was in a close relationship to the Bank and its money. So as time progressed the Bank’s clients started pulling money out to meet their liquidity needs, for money becomes scarce in an inflationary environment. So SVB started looking for ways to meet its customer withdrawal. It had no options but to sell the Government bonds to meet its immediate cash requirements. So a bond portfolio of around $21 billion consisting mostly of US Treasury bonds were sold off albeit with a loss of about $1.8 billion which then was needed to be filled through capital raise. The process continued when SVB announced a stock sale of $2.25 billion in common equity and thus preferred Convertible stock to fill its funding hole. Its shares by the way ended trading on the day down 60%. On the advice of Venture Capital firms such as Peter Thiel’s Future Fund, this happening spoiled investors such as General Atlantic. The depositors started lining out of the bank to get their money out as soon as possible and adverse conditions were created which was a promise of further turmoil. Then SVB scrambled to find alternative funding including through a sale of the company itself. Federal Deposit Insurance Corporation (FDIC) which oversees such operations or the system as a whole and then it was announced that SVB be shut down.
Further it was informed by FDIC that it was seeking to sell SVB ,its assets and also made a promise to the depositors that all of their funds and deposits would be protected.
Regulations Concerning Bankruptcy and Fund Protection
The regulations that were framed after the 2008 financial crisis to ward off any kind of a similar problem seemed to show their efficacy but the laxity of banks and financial institutions in the post Covid scenario made way for this crisis to spurt out. Regulators further had imposed more stringent requirements for US banks aimed at ensuring a minimum negative impact on the financial system as a whole. 89% of the bank’s $175 billion in deposits were uninsured at the end of the year 2022 according to FDIC. This meant that most of the deposits were not protected by government backing in case of a bank failure. A $250,000 limit had been placed as to the amount that would be insured and returned in case of a failure. The clientele as we know mostly consisted of Techies and startups where the amount for the normal running of the business on a daily basis far exceeded the insured amount. This in fact tipped off the whole problem and then the financial environment and the general economic situation further exacerbated the whole issue.
Is it the Start of a Banking Crisis?
The US Government here was quick to respond in guaranteeing all deposits of the Bank’s customers. The March 2023 crisis exposed the heath of the banking system as a whole and pointed out the everlasting problems especially the cyclical ones which repeatedly attack the general economy both nationally and internationally. Signature Bank also failed in addition to the Silicon Valley and their relationship to the Technology startups which have an added risk and so on could be one of the major points that probably has led to their demise. This is evident as to how our whole system is connected in a very complex and absurd manner where a turmoil in one of the parts leads to a turmoil in the other ones and eventually the whole structure gets ridden by the problem and gloomy trends.
However the long term question is whether SVB’s vulnerability to rising interest rates is paralleled in other banks through an over exposure to falling bond prices under inflationary pressure. There does lie the more immediate concern for the technology sector. SVB catered for Silicon Valley and backed startups and so on. This does present a challenge to the restive Tech industry especially the startups and it could be a sign of gloomy trends in the future too but what would be the extent of the problem and whether it would happen on a macro or micro scale is yet to be observed.