The Silicon Valley Bank’s collapse due to a bank run is regarded as one of the longstanding issues in the banking industry, and the United States had not witnessed a banking crisis of this scale since 2008.
On Friday, California banking regulators shut down Silicon Valley Bank, which was the 16th largest bank in the US until the end of 2022, due to its collapse caused by depositors withdrawing their money earlier this week after learning of the bank’s weak financial position. SVB’s depositors were primarily individuals employed in the tech industry and firms operating on venture capital. The bank’s situation is regarded as one of the traditional issues in the banking industry, namely, a bank run.
What is a bank run, you might ask?
A bank run is a situation where many people try to take their money out of a bank at the same time because they are worried the bank might not be able to give them their money back. This can happen if people lose confidence in the bank’s financial health, leading to a rush of withdrawals that can potentially lead to the bank’s collapse.
Reuters reported that there were multiple factors behind the collapse of Silicon Valley Bank, including the Federal Reserve’s increase in interest rates, some of the bank’s clients experiencing a cash shortage, and the bank selling a bond portfolio at a loss. The report stated that the higher interest rates made investors cautious as their investments became more expensive.
Why is that?
Bond prices have an inverse relationship with interest rates because of the way bonds work. A bond is essentially an IOU issued by a borrower, such as a company or a government, to an investor who has lent them money. The bond has a set interest rate, known as the coupon rate, that the borrower must pay to the investor over the life of the bond.
Imagine that you are an investor holding a bond with a fixed coupon rate of 2% per year, and interest rates in the economy rise to 3%. Suddenly, newly issued bonds are offering investors a better return than your bond. As a result, your bond is now less attractive to investors looking for a return on their investment. To sell your bond in this case, you would have to lower the price of the bond to make it more appealing.
On the other hand, if interest rates fall to 1%, your bond suddenly becomes more attractive, as its coupon rate is higher than the prevailing rate in the economy. As a result, investors may be willing to pay more for your bond, driving up its price.
This was exacerbated by the liquidity problems faced by startups, which were the primary clients of SVB. The higher interest rates caused the IPO market to close, making private fundraising more costly, and prompting these companies to withdraw their funds from the bank.
in an attempt to remedy the situation, SVB sold a bond portfolio valued at $21 billion, mostly comprised of US Treasuries, resulting in a loss of $1.8 billion.
On Monday, European stock markets experienced a decline as investors continued to be concerned about the impact of Silicon Valley Bank’s collapse, despite attempts to minimize the consequences. There were significant drops in bank shares, including a 12% decrease in Germany’s Commerzbank and a 7% decline in Santander, highlighting concerns about the sector’s well-being. In London, the FTSE 100 index closed down 2.6%, and share prices continued to decrease even after HSBC’s agreement to purchase SVB’s UK division. The US markets initially followed the banks’ lead but recovered later and ended up being flat.