As you probably heard on the news recently, Silicon Valley Bank (SVB) collapsed in about 48 hours! This is shocking and scary for all of us who have money saved in banks. At the time of the collapse on March 10, 2023, SVB was the 16th-largest bank in the United States.
Why did Silicon Valley Bank collapse?
In order for you to fully understand what happened to Silicon Valley Bank, you must understand a few concepts about investing and how banks work.
- When you deposit money in a bank, they usually invest your deposit in bonds.
- When interest rates are high, bonds price goes down and when interest rates go down, bonds price goes up.
- When banks have a high demand for withdrawals, they have to sell their bonds to cover the withdrawal requests.
- Deposits are insured up to 250k
Silicon Valley Bank specialized in doing business with start-up tech companies, such as Google, Facebook, Amazon, etc. Therefore, when a tech company proposes a business idea to them, they funded the startup business. In return, they own a significant portion of the business, so if the idea was a hit, they made a lot of money.
They bought long-dated Treasuries
A few years ago, the tech sector was booming, so many of their customers were depositing their money in this back and SVB invested it in long-dated Treasuries. Why? Because when you deposit money in a bank or credit union, they typically invest your deposit in bonds, and that is how they can secure the interest they pay you.
Interest rates affect bond prices. When the interest rate goes up, the price of the bonds goes down. Then, when in interest rate goes down, the price of the bonds goes up. As a result, bond prices fluctuate between the purchase date and the maturity date.
Demands for withdrawals were unsustainable
Given that the tech sector is down significantly, SVB started to hold back on lending money. Due to this, many companies that borrowed money from SVB to fund their business expenses no longer receive it. Instead, they had to start withdrawing their saving from SVB. Consequently, SVB was forced to start selling its bond holdings to meet the withdrawal demand. This is when everything started to go downward for SVB.
Their customers started to panic
When SVB customers deposited their money, bond prices were high. Fast forward to now, the price of bonds is significantly low. This is due to the current high-interest rates. Therefore, when SVB announced that they had sold their bonds holding at a serious loss to cover the high demands of withdrawals, a red flag went up for investors and their depositors.
Lastly, they announced that they were going to sell 2.25b worth of their share, so everybody started to panic. They started withdrawing all their money from the bank and selling their shares. This started the run on the bank and led to its collapse.
They tried to raise more capital to meet the demand of their customer, but before they could do that, the regulators of California shot it down and placed it in receivership under the FDIC.
Conclusion
After all, the collapse was due to Silicon Valley Bank buying too many long-dated Treasuries in a rising interest rate environment. Then, they had to sell them at a loss in order to pay back their depositors. This led to panic among their customers and to the unsustainable high demand for withdrawals.
What does this mean for their customer?
Federal regulators decided to create an exception to the $250,000 maximum eligible for federal deposit insurance, promising to reimburse all depositors.
What to learn from this?
The bigger lesson to learn from this is that you should not have more than $250,000 in a bank or credit union unless you have more than one beneficiary in the account. Also, when interest rates go up, it affects many people including big corporations like Silicon Valley Bank.
