- 1 Silicon Valley Bank Crash Explained
- 2 Let’s try to understand it in today’s article.
- 3 Friends, to understand this situation, We need to first understand How banks work?
- 4 So why did this bank crash?
- 5 And SVB was the #1 preference of technology-based startups.
- 6 In case you aren’t familiar with bonds,
- 7 According to America’s Federal Reserve,
- 8 Is not kept safe in a huge vault.
- 9 SVB started selling the bonds.
- 10 The bank did not commit any fraud.
- 11 When the economy of a country is facing a slow-down,
- 12 On the other hand, if inflation is on the rise in an economy,
- 13 One of which is the Russia-Ukraine War.
- 14 what would happen to the funds of the people and companies that were deposited with the bank?
- 15 National Bank of Santa Clara.
- 16 When the PMC bank crashed in India
- 17 US banks have wiped out over $100 billion from the stock market.
- 18 And European banks have wiped out about $50 billion.
- 19 They use a single bank account.
- 20 Paytm founder Vijay Shekhar Sharma reveals
- 21 The downfall of American Banks
Silicon Valley Bank Crash Explained
Two of America’s major banks have collapsed. California’s Silicon Valley Bank and New York’s Signature Bank. This is said to be the second biggest banking failure in American history. The 2008 collapse of the Washington Mutual Bank was the biggest. It was followed by the 2008 financial crisis. Bringing a global recession. People are worried that this banking collapse might create another recession like in 2008. Because if America’s financial system crashes, The impact can be seen all over the world. What happened exactly? How did it happen? And what will be the probable impacts? Come,
Let’s try to understand it in today’s article.
Friends, to understand this situation, We need to first understand How banks work?
From the perspective of an individual, Bank is the place where we keep our hard-earned money We deposit our money with the banks for safekeeping. But from the perspective of a bank, The bank is running a business. They won’t work for you for free. Banks have a distinct business models. The money deposited by you with the banks, Banks would want to use it to make money for themselves. There can be different ways of making money. For example, giving loans to other companies and individuals. The interest charged on that loan would be the profit for the bank. The second source of income is investing in various places. Banks invest the money deposited with them in the stock market, government bonds or for buying gold for example. Similar to how individuals invest their money at various places, Banks can do the same to earn more money.
And you can understand it better with the example of the Silicon Valley Bank. Coming to the SVB, it was established in 1983. Its headquarters are located in Santa Carla, California. And initially, this bank invested a large chunk of its money into real estate. In the early 1990s, half of this bank’s portfolio, Was made up of the real estate property business. All your investments are collectively known as a portfolio. Every person has a portfolio. Any investment into stocks, gold, or even in cash, Makes your portfolio. You would have seen financial experts advise that Every portfolio needs to be ‘diversified’. One shouldn’t invest all the funds into a single asset. It is highly risky. Suppose you use all your savings for buying gold. Since someone told you buying gold is a good investment option. And then one day, the gold market crashes. What would happen to you? Your savings turned into dust. Friends, something similar happened to SVB back then. 50% of their portfolio was real estate investments.
After this, the bank realized that they need to diversify their portfolio, So after 1995, the contribution of the real estate business has remained around 10%. Why did I tell you this? Because the bank is going through a similar thing. But on a much larger scale. Moving on from 1995 to the 2000s, The bank was known for a new thing. This bank was heavily investing in startups. Especially, technology-based startups. The technology-based companies that were in the venture stage, The bank would give loans to those companies specially. By 2015, the bank had expanded so much, it was reported that 65% of all startups in America Were served by this bank. The companies in the tech industry, Were the biggest customers of SVB. The name fits the bank very well. The technology-based companies in Silicon Valley, Were banking with the Silicon Valley Bank. Friends, several Indian technology-based startups were also among these companies. In this aspect, the SVB was quite unique. It was working almost exclusively for technology-based startups. But the other banks look for diversified customers to give loans to.
So why did this bank crash?
Friends, the problems began with the Covid-19 pandemic. With global lockdowns, venture capitalists from all over the world, Began investing in software companies. People saw that even during the lockdown when everything else had to shut down, Software-based companies are the most successful. That runs through computers and mobile phones. This is why in 2021, the startups raised a lot of money. In America, $330 Billion was raised in total. Almost double the record of the previous year. If these technology-based startups have so much money They would want to deposit the funds with the bank.
And SVB was the #1 preference of technology-based startups.
This was a huge jump with so much money being deposited into the bank suddenly. Compare this to the other banks, They did not see such a large jump. JP Morgan Chase Bank saw an increase of 24% only. Since the bank had so much money in the form of customer deposits, They decided to use it to make even more money. So SVB used the billions of dollars, To invest in government bonds. Friends, this wasn’t unusual. As I told you earlier, Banks have their business models, They can invest the deposits at various places to make more money. And investing in government bonds is considered relatively very safe. Not only government bonds but corporate bonds were also bought as investments.
In case you aren’t familiar with bonds,
Allow me to explain it in brief. When large companies or governments are in need of funds They issue bonds. When you buy the bonds and invest your money in it, The money would go to the issuer And would be used by them. But in a way, this money is akin to a loan from you. The issuer promises you interest rates. And at the end of the period of the bond, suppose 5 years, The issuer would return your money with interest. So investing in bonds is often beneficial for you. Basically, by investing your money, you will receive interest at predetermined rates. This will be your profit. And for the issuer, this is a source of borrowing. They issue bonds due to the immediate need for funds. SVB bought a large number of bonds at a time when The prevailing interest rates in the market was quite low.
According to America’s Federal Reserve,
It was expected that the interest rates would remain low, But this didn’t happen. The interest rates increased. Without going into too many technicalities, All you need to understand is that bond price and interest rate have an inverse relationship. If interest rates go down, bond prices go up. The longer period you hold the bond, the riskier it becomes. The interest rates can fluctuate while you’re holding onto it. The price may fluctuate. It might benefit you or may cause you losses. But if the price of the bond you’ve bought falls, You will have to bear the losses. This turned into a worst-case scenario for SVB. The American government increased the interest rates. By raising the interest rates, the value of the bonds held by SVB crashed. They suffered a huge loss. But this wasn’t the only loss. The second negative impact was even greater. By increasing the interest rates The interest rate on borrowing loans increases as well. For startups and companies, taking loans became more expensive. So they would avoid taking loans. What else could they do to meet the funding requirements? They would use the money they have deposited into the banks. By 2022, after the interest rates had increased, The tech startups wanted to withdraw their deposits to meet financial needs. Venture capitalists weren’t funding them anymore. Since they had their deposits with SVB, they wanted to make withdrawals at the same time, It became problematic for the bank.
Is not kept safe in a huge vault.
Only a small percentage of the deposits are actually stored. And the rest of the money is used for investing and providing loans. It means that if all the customers of any bank want to withdraw money at the same time, The bank would not have enough funds available. SVB faced the same situation. On one hand, the funds they had invested were incurring losses. And on the other hand, their customers want to withdraw their deposits. Due to the demands of the customers,
SVB started selling the bonds.
Avoiding the downgrade was another reason They sold the bonds at a loss of $1.8 billion. As soon as the news became public, The value of the shares of SVB began increasing. As on 9th March 2023, the shares of this bank were down by 60%. The day before, the rating of SVB was downgraded by Moody’s. At this point in time, no matter what the bank did, it would have been impossible to avoid the crash. As soon as the news broke that the bank did not have enough funds And that it was selling its investments At billion of dollars in losses, Everyone that had deposited their money with the bank, rushed to withdraw it. They were worried about their money. And everyone rushed together to get their money back. This is known as a Bank Run.
But the actual reason why this situation was created Was different in the other 2 cases. Whatever happened here, according to the publicly available information, There was no scam.
The bank did not commit any fraud.
Though it is true that the bank hid some facts And did not make timely disclosures to the public, But this is a case of bad decision-making. People in charge of the management of the bank made wrong decisions, It turned out to be the wrong time, and to some extent, this was simply bad luck. You might be thinking that the root cause was the increase in interest rates by the US government, Why did the government do this? Friends, there’s a simple reason for it. To control inflation. Friends, there’s an interesting relationship between inflation and interest rates.
When the economy of a country is facing a slow-down,
The central bank often reduces the interest rates. So that it is easier for people to take loans. With low interest rates, more people would want to take loans. With more loans, more people would have expendable money. More expendable money would mean that they can spend on various things. With this, the money circulation in the economy would increase And it would boost the GDP. This is why during the pandemic, interest rates were lowered by the government.
On the other hand, if inflation is on the rise in an economy,
Interest rates are increased to control it. Increasing interest rates would make loans more expensive. Fewer people would want to take loans. People would not have enough money to spend, And the spending would decrease. With lower spending, inflation could be controlled. This is a general and simplified explanation. Over the last several months, inflation was rapidly increasing in America and Europe Due to several reasons,
One of which is the Russia-Ukraine War.
To control this inflation, the Federal Reserve increased interest rates. Though this can be considered the root cause, Bad decision-making by the bank was also at play here. Interest rates will continue to fluctuate, You need to have a robust portfolio So that it can bear these fluctuations.
what would happen to the funds of the people and companies that were deposited with the bank?
There’s a limit to insurance. To a certain limit, the money deposited with the banks is insured. That is the law. In America, the limit is $250,000. This might seem like a large limit. But the clients and customers of SVB, Were startups with a lot of money. It is reported that 89% of the deposits were uninsured. But the response of the American government was similar to the Indian government’s response when Indian banks crashed. The California Department of Financial Protection and Innovation pounced on the SVB’s office. The receivership of the bank was handed over to the FDIC. Federal Deposit Insurance Corporation. Customer deposits to the tune of $175 billion Was used by FDIC to create a new bank.
National Bank of Santa Clara.
The assets of SVB were taken over So that usual business activities could be continued. And then began the search of a bank willing to merge with SVB. That’s right. Merger is a solution here. 2.5 years ago,
When the PMC bank crashed in India
The Indian government did the same thing. The PMC Bank was merged with the Unity Small Finance Bank. To ensure that the deposits of the public could be safeguarded And later could be withdrawn safely. In the case of SVB, it is yet to be seen which bank would it merge into. But US President Joe Biden has assured that The deposits made with the bank would be safe. That even the uninsured money would be safe. But a major impact of this bank crash is that In the stock market, the value of US banks has taken a nosedive.
US banks have wiped out over $100 billion from the stock market.
And European banks have wiped out about $50 billion.
Several companies that had deposited their money in SVB Have lost share value due to this. Such as streaming device maker Roku Inc. Which reported that their deposits with this bank were largely uninsured. They lost about 10% of their share value. Y Combinator is a startup accelerator platform. SVB was the default bank of Y Combinator. The startup founders who used this platform Usually opened their accounts with SVB.
Several Indian startups and Indian founders were using this platform And had deposited their money with SVB. This is very problematic for startups Because unlike big companies
Most startups do not have multiple bank accounts across various banks.
They use a single bank account.
They are often very critical of their money Because they have to pay the employees, And bear the operational costs to run the startups. They are in dire need of funds.
Paytm founder Vijay Shekhar Sharma reveals
They had earned a huge return on their investment of $1.7 million. Overall, its impact on the American and global economy is yet to be seen.
The downfall of American Banks
Though people are comparing it to the 2008 financial crisis, There is a critical difference. The 2008 crisis was due to the crash of the American housing market. Banks had lent a sleuth of irresponsible housing loans To people and companies who could not afford to repay it. So the housing market crashed And a global recession followed. After these several strong regulations have been imposed, and New laws have been enacted So that it doesn’t happen again. Experts believe that in the current situation, Matters will not get as bad, Because SVB served customers largely of a specific sector. There might be an impact on those startups, But a global financial crisis would be unlikely.
I hope you’ve understood the situation better.
Thank you very much!