The collapse of SVB, the second-largest in US history and the largest since the global financial crisis of 2008, has sent shockwaves through the financial world. The circumstances surrounding this event have raised concerns about the stability of the US banking system and its potential impacts on the global economy.
Understanding why SVB collapsed requires a brief examination of how banks operate. Banks accept deposits, make loans and investments, and profit from the difference between interest paid to depositors and the rate charged on loans or earned on investments. However, banks usually do not have sufficient cash available to meet large-scale withdrawals, which can lead to a run on the bank.
In SVB’s case, deposits rose dramatically between 2018 and 2021. The bank invested heavily in long-term US Government bonds when interest rates were low, earning steady returns. However, SVB failed to anticipate the Federal Reserve’s interest rate hikes, which led to the devaluation of their bond holdings as new, higher-yielding bonds entered the market.
As interest rates increased, SVB’s clients, primarily technology start-ups, began withdrawing their deposits. To fulfill these withdrawals, SVB had to sell some of its assets, including bonds, at a loss. Reports indicate that SVB lost $2 billion on the sale of its existing bonds, eventually resulting in a liquidity crisis and the bank’s collapse.
The US Government intervened, but only a small portion of SVB’s deposits qualified for deposit insurance. Two other mid-sized US banks and one large European bank, Credit Suisse, also required assistance. Despite these events, the US Treasury Secretary has assured Congress that the US banking system remains sound and resilient.
Although the current situation is not as severe as the 2008 crisis, it has exposed weaknesses in the banking system that must be addressed. The scale of the problem is smaller, and most banks have stronger capital bases and improved risk management, but confidence in the US and global banking systems has been shaken.
The wider impacts of this turmoil remain uncertain. These recent failures could be isolated incidents with little global impact, or they could signal the beginning of a more significant problem. One potential consequence is a credit crunch, which could increase the risk of a US recession and have global implications.
As economists and analysts around the world closely monitor this unfolding situation, we can only hope that the worst has passed. However, the collapse of SVB serves as a stark reminder that the financial system’s vulnerabilities must be continually addressed to ensure stability and resilience in the face of unexpected challenges.