Have you ever tried keeping your breath for too long? For sure, at some point in your life, you have experienced that feeling of panic as your lungs scream for air. Well, that’s what our economy would experience if money suddenly stopped circulating. Money is the main oxygen provider to our economy, and banks are the lungs of the financial world, constantly oxygenating our whole economy with money.
Undeniably, banks play an instrumental role in our economy, which is why everyone got shit-scared when Silicon Valley Bank’s stock value plummeted. SVB’s recent collapse has sent shockwaves throughout the financial system and has exposed fault lines that run deep beneath the surface of one of the most successful financial systems of the world. SVB was seen as a critical player in the tech industry for years. The bank was there to help fuel the growth and innovation we’ve seen over the last years through loans and investments.
One of the faults exposed by the bank’s debacle was the unusual-ending practices that had somewhat started to become commonplace in the industry. For years, the bank had made loans to startups, hoping to cash into the next big thing. One of the most unusual lending practices the bank was engaged in was its so-called venture debt which can be found on the bank’s website1. Instead of focusing on the startup’s cash flow and future prosperity, this type of lending gave loans based on the size of funds the startup recently raised.
The bank has made these loans to startups between 25% to 30% of the capital they had recently raised. SVB’s venture debt relied entirely upon the ability of the startup to raise money for another round to pay the loan bank. Whilst this might have been quite profitable when the interest rates were to the ground, the startup funding took a sharp decline as soon as the interest rates surged. That’s because borrowing has become much more expensive than before.
But this is not what ultimately pushed the bank over the edge and caused its stock to plummet. There’s more to the story, which exposes yet another fault line that raises significant concerns moving forward.
Since 2020, the bank has been investing in safe assets such as Treasury bills and government mortgage bonds. With the rise in inflation, the Fed had to increase the interest rate at a record rate. As the interest rates went up, the value of these bonds fell. Remember that there is an inverse relationship between bonds and interest rates. Bond prices begin to fall as soon as interest rates begin to fall and vice versa.
As a result, those assets’ value was significantly lower than what SVB had paid for initially. It is estimated that the bank was sitting on $17 billion in potential losses on those assets. Then when the bank announced a capital raise and that it was selling a large number of securities at a loss, fear increased among investors. This fear then led to a tidal wave of $42 billion of deposit withdrawals, which the bank simply did not have the assets to cover for them all.
The chart above from StockCharts shows how the SVB’s stock plummeted by 60% on Thursday, a day after it had announced that it had sold a bunch of securities at a loss and would sell $2.25 billion in new shares. By Friday morning, the trading in SVB stocks halted, and the Silicon Valley Bank was closed by the California Department of Financial Protection& Innovation and the Federal Deposit Insurance Corporation.
A main fault line that the SVB’s debacle exposed is the effectiveness of the digital world and the rate at which information travels, enhancing bank runs and undermining the financial system. The rate at which information travels now is much higher than it was ten years ago and even higher than 20 or 100 years ago. Coupled with the ease of conducting financial transactions in this day and age, it makes a perfect recipe for the financial collapse of not only banks but the entire system.
And it’s pretty easy to act on any information nowadays. You just have to open your Robinhood account or any other broker you might be using and sell SVB’s stock or any other stock in the blink of an eye.
This also helped amplify the ripple effect the collapse of SVB created on other banks, revealing the interconnectedness of banks with each other. The collapse didn’t just impact businesses in Silicon Valley but many other banks in the economy. Fear prevailed amongst investors, and many started selling bank stocks. This interconnectedness between banks means that the failure of one bank can have far-reaching consequences, potentially destabilizing the entire system.
The chart above from StockCharts shows the fall that the NASDAQ Bank Index experienced shortly after the collapse of SVB. The NASDAQ Bank Index comprises securities of NASDAQ-listed companies classified according to the Industry Classification Benchmark as Banks. Signature Bank was another bank that experienced large withdrawal deposit requests as fear amongst investors was rising. More than 100 billion in market value was wiped out due to the SVB crisis.
While many banks could weather the crisis and the rise in investor fear, others weren’t as lucky. Signature Bank was catering to private companies, and likewise, SVB had significant amounts of uninsured deposits. Regulators shut down Signature Bank on March 12, as the bank experienced losses on their bond portfolio and a run on deposits.
The collapse of Silicon Valley Bank has highlighted the need for banks to have robust risk management practices and for regulators to maintain close oversight to prevent similar situations in the future. The impact of a financial institution’s failure, particularly one as large and prominent as SVB, ripples through the economy, shaking the confidence of investors, customers, and stakeholders. The fallout from such a failure can be severe and long-lasting. It’s a wake-up call to ensure the banking system is resilient and can withstand potential shocks.
References
https://www.svb.com/startup-insights/venture-debt/how-does-venture-debt-work
