What Happened with Silicon Valley Bank?

What Happened with Silicon Valley Bank
What Happened with Silicon Valley Bank?

For the last week, all eyes in the financial sector have been on Silicon Valley Bank. You’ve probably seen it in the news and on Twitter, but bank runs can be hard to grasp unless you’re a finance expert.

Last Friday, Silicon Valley Bank in California was taken over by financial regulators, and just two days later, the New York-based Signature Bank shut down business for similar reasons. In a nutshell, both were casualties of bank runs.

Bank Runs
Bank Runs

What are Bank Runs?

To understand what happened here, first we need to understand what “bank runs” are. Bank runs occur when a sizable group of bank customers withdraw their deposits all at once. Banks are often prepared for normal business with their customers, regular deposits and withdrawals, at different times by different customers. But, in a bank run, when they all attempt to withdraw their funds from the bank at once, this can present a major issue for the banks holding their customers’ funds.

The thing about bank runs is they can happen for all kinds of reasons. Often, as in this case, the stampede to withdraw is the result of customers’ fear of the bank’s solvency. This can be a rational fear based on legitimate cause for concern, or a fear based on merciless PR or strategic financial power plays. In any case, the outcome is a large percentage of bank customers all asking for everything (their money), everywhere, all at once.

Silicon Valley Bank
Silicon Valley Bank

What Happened with Silicon Valley Bank?

Last week we saw the biggest bank failure since the global banking crisis of 2008. Then it happened again with Signature Bank two days later. Regulators in California closed the bank, put the FDIC in charge of its assets, and left the federal government trying to explain what had happened and how they were going to handle it.

SVB had more than half of its assets invested in fixed-income securities, like government bonds. For the last year, the Federal Reserve has been dramatically raising interest rates on those securities to try to counter the surge in inflation. This temporarily reduces the value of those securities. As long as the owner can hold on to them for the duration, the value will eventually return to what it was, no harm no foul, at least for the securities owners.

The problem here is that SVB couldn’t hold on to them once their customers started increasing their withdrawals from the bank beyond what their cash reserves could cover. So, they sold $21 billion of those securities at a loss of nearly $2 billion. To cover that loss, the bank began to try to raise new capital.

This is when things got out of control. SVB customers saw that the bank was desperate to raise new capital and panicked. Everyone wanted their cash out of the bank immediately, especially because the vast majority of customers’ funds were not covered by deposit insurance. No bank is prepared for this. The failure at Signature Bank was an aftershock of the SVB situation, with their customers seeing what happened with SVB, knowing their deposits were similarly uninsured, and scrambling to withdraw their funds.

Banking Crisis 2023
Banking Crisis

What Does This Mean for the Economy?

Well, for starters, it’s probably a deeply unsettling time to be in the banking industry. The major contributing factor in both cases here was a side effect of inflation and the dramatic interest rate hikes by the federal government over the last few years to try to curb it. Inflation is a serious issue all over the world, for everyone from individuals to the largest financial institutions in the world.

Of course, most large healthy banks are prepared to withstand the unrealized losses that interest rate hikes can cause, as well as the liquidity risk that both SVB and Signature faced this week. But, as those banks proved, not every bank is large and healthy. We all learned this in 2008, so it’s concerning to see it happening again.

The Biden Administration’s response has been to protect depositors, the bank’s customers, rather than bail out the bank, and prevent future bank runs beyond the initial crisis. SVB and Signature Bank’s depositors received virtually unlimited coverage from the Federal Government, not just the $250,000 typically covered by FDIC deposit insurance.

We saw the results in the stock market on Monday when the stock price of similar mid-sized regional banks saw huge declines. For example, First Republic saw a traumatic 62% drop in its shares. Notably, large, well-established banks were spared, preventing this from becoming 2008 all over again.

It’s still early days, but it seems the government’s response to these two individual banks was to let them hang out to dry, while protecting the customers. As Biden himself said, “That’s how capitalism works.”

Investing for Growth
Investing for Growth

What Does This Mean for You?

So, as someone who isn’t managing or invested in a bank, what do you do with this information? Yes, the government covered these banks’ depositors this time. It’s nice political PR – protecting the customers and not the risk-taking banks themselves. But what happens when the banks in question aren’t mid-sized regional banks? Can the government really cover those losses beyond the $250k insured by the FDIC? The 2008 financial crisis would suggest no.

For individuals, this is yet another reason not to let your money sit in the bank collecting dust! While it earns interest just sitting in the bank, it’s a tiny return no matter the size of your account. If anything, this should be a wake-up call to individuals to make your money work for you.

But isn’t investing risky? Well, the collapse of these banks proves that there is still a risk of leaving your money in a bank, especially in the current economy. And while there is inherent risk in any kind of investment, long-term, well-informed stock market investing can provide returns far beyond anything savings account interest can provide.

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