Silicon Valley Bank Failure Sparks Global Financial Jitters

On March 11, 2023, Silicon Valley Bank (SVB), a leading institution in the American banking sector boasting over $200 billion in assets, shockingly declared bankruptcy without any prior warningThis unprecedented event is regarded as another monumental failure of a financial giant since the 2008 financial crisis, leaving many in disbeliefWhat is even more astonishing is that the entire sequence from the initial signs of trouble to the bank's ultimate collapse occurred within a mere 48 hours.

The repercussions of this crisis rippled rapidly across global financial markets, impacting the American stock market, the banking sector, as well as European and Asian marketsEven the cryptocurrency world felt the tremorsThe pressing question arises: what actually happened, and why did SVB crumble so suddenly? How does this monumental collapse relate to the average person? Allow me to unpack this for you.

To properly contextualize these events, we need to rewind back to early 2020, when the COVID-19 pandemic struck like a fierce storm, plunging the global economy into a deep recession

In a bid to stimulate the sagging economy, the Federal Reserve slashed interest rates by 0.5% on March 3, 2020. Just twelve days later, on March 15, the Fed took drastic measures to lower rates down to a range of 0-0.25%, introducing a 'zero-interest' policy to kickstart the economy.

This series of interest rate cuts inadvertently intertwined the fate of SVB with the broader economic landscapeDuring this period, SVB experienced an influx of nearly zero-cost depositsFrom June 2020 to December 2021, its deposit numbers surged dramatically from $76 billion to over $190 billion, akin to a rocket launch in financial terms.

For depositors, these funds represent wealth accumulation; however, for the bank, they constitute liabilities—specifically low-cost liabilities that required minimal interest commitmentsWith such a substantial pool of capital, SVB began to explore investment opportunities for these funds

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Given its association with Silicon Valley, it indeed invested in local startups, but the demand for loans from these startups did not keep paceIn fact, the demand began to wane.

Consequently, SVB shifted its focus to investing in low-risk government bonds with maturity periods of one to five yearsWhile these bonds seemed stable, they offered only a 1% yieldNonetheless, with almost zero costs involved, SVB thought it could at least secure some profit.

However, there was a critical issue at play: these government bonds were primarily buy-and-hold securitiesIn layman’s terms, this means that the bank could only recoup principal and interest upon maturityIf they attempted to withdraw funds early, not only would they forego interest, but also incur principal lossesThis scenario resulted in a ‘mismatch of maturity’ risk—where short-term funds were locked into long-term investments.

To illustrate this concept: demand deposits are akin to short-term loans easily accessible to depositors at any time; whereas five-year government bonds represent a long-term commitment with funds effectively tied up

Theoretically, while all depositors could demand their money back at once, banks cannot recall their loans as swiftly.

How do banks manage this potential mismatch? We can touch upon the reserve requirement system employed by banksHave you ever considered how much cash banks need to hold in reserve to adequately respond to potential withdrawal demands from depositors? In principle, the likelihood of all depositors withdrawing their funds simultaneously is negligibleGenerally speaking, maintaining a certain ratio of cash reserves allows banks to efficiently handle the majority of daily withdrawal requestsThis is why central banks worldwide have implemented reserve requirements.

For instance, in China, the reserve requirement ratio is maintained at approximately 7.8%. Conversely, the United States, in an effort to boost the economy, had reduced this ratio to 0% at one point.

It’s natural to wonder, what happens to our deposits if a bank goes belly up? After all, banks aren’t infallible institutions that will survive every fluctuation

In China, if an individual's deposits in a single bank do not exceed 500,000 RMB, and that bank faces bankruptcy, the corresponding insurance agency will compensate the individual for the amount.

Consequently, many individuals adopt a risk diversification strategy, spreading their money across multiple banks, ensuring the deposited amount remains within the insured limitHowever, this strategy poses challenges for larger corporate depositsIn the United States, the insurance payout ceiling stands at $250,000; it is staggering to find that 90% of SVB’s deposit structure surpassed this threshold, leaving most depositors at risk of losing a substantial amount should a calamity strikeMany could only silently hope such extreme situations would not unfold.

Unfortunately, fears often become realityStarting in 2022, the Federal Reserve began a series of interest rate hikes, reaching a range of 4.5%-4.75% by February 2023. SVB’s yield on government bonds at just 1% meant that its cost of funds soared above 4%—heralding a state of operational loss for the bank

These losses, deemed "unrealized," would only surface once the bonds matured.

The situation worsened as the technology industry in the U.Sfaced a severe downturnBeginning in the second half of 2022, major players like Tesla, Facebook, Microsoft, and Twitter suffered widespread layoffs, resulting in significantly slashed budgets, hiring freezes, and venture capital firms adopting a pessimistic outlook on the American economy.

As SVB’s primary clientele comprised numerous tech enterprises, the tightening investment environment compelled many startups to draw upon their bank deposits frequentlyThis relentless demand caused a massive liquidity crisis for SVB as funds swiftly flowed out.

To bridge the financial gap, SVB sought to sell assets, yet the bulk of its holdings were in buy-and-hold bondsEarly liquidation resulted in significant losses—when SVB sold $21 billion in securities, the bank suffered an immediate loss of $1.8 billion, shocking investors and igniting panic in the market.

On March 8, the floodgates opened with withdrawal requests, totaling over $42 billion

In a swift response to SVB's turmoil, startups and venture funds rushed to pull out their assetsWith only around $10 billion available, SVB found itself overwhelmed, ultimately conceding to bankruptcy.

The devastation of this event cannot be understated; Y Combinator’s CEO, Garry Tan, described the situation as a catastrophic disaster for startupsThe prospects for many burgeoning companies hanging in the balance, as Tan warned, if those funds dissipated, numerous startups could vanish from the market entirely.

Following the incident, 125 venture capital institutions, including Sequoia, urgently called upon the government to interveneThey expressed willingness to collaborate with any potential acquirers of SVB, emphasizing the readiness to support efforts aimed at salvaging the situation.

Elon Musk shared his thoughts on Twitter, acknowledging the uncertainty regarding future developments and maintaining a wait-and-see stance.

This incident serves as a glaring warning sign: the hazard of 'short-term borrowing for long-term investing' is immense