Bank Run Season: The Collapse of Silicon Valley Bank
Monday, 27 March 2023
What is Silicon Valley Bank?
These past few weeks saw the collapse of one of the world's 15 largest creditors, Silicon Valley Bank (SVB). The failure of a large central institution has not occurred in the United States since Washington Mutual in 2008. Headquartered in Santa Clara, California, SVB is known for its involvement with big tech. SVB dedicated its financial offerings to Silicon Valley startups to assist them with early-stage fundraising and provide them with strategic advisory services to enable scalability. SVB has significantly financed some of the world's most successful technology companies, such as Apple, Google, and Amazon.
On March 10, 2023, SVB became insolvent (the inability to pay debts) after a bank run obliterated its share price and the value of its reserve holdings. SVB did not have enough base capital in its reserves to meet customer withdrawal requests and immediately defaulted on all payments.
Of its $211 billion in managed wealth, mortgage-backed securities accounted for over 50% of SVB-held assets, totalling around $117 billion in value. SVB was way overexposed to mortgage bonds—a type of debt security backed by a pool of underlying mortgages—which crashed in price due to the continuously rising interest rates in the United States. SVB being overexposed to fixed mortgage bonds was disastrous because the value of those bonds, regardless of the type of mortgage that backed them, decreases as interest rates rise.
In an open mortgage—which allows for principal repayment at any time—interest rate hikes increase prepayment risk as people want to pay off their mortgage faster. So, suppose a mortgage bond has a fixed maturity rate of 10 years, but interest rates rise, and a borrower manages to pay down their principal mortgage payments in 6 years instead of 10. Bondholders would not receive the yield they were entitled to over that 10-year maturity period and hold these assets at a loss.
In a closed mortgage, rising interest rates could cause people to refinance their mortgages at a higher fixed interest rate to reduce their monthly principal payments. This extends the time the principal can be paid beyond when the bond reaches maturity, causing bondholders only to receive a partial amount of the expected payments.
SVB had no choice but to sell its mortgage bond securities at a loss and issue over $2 billion worth of new shares to cover its balance sheets. Such an increase in stock supply would be very catastrophic for its price if all new SVB shares were issued at once. This possibility triggered a wave of panic selling among SVB investors, which completely butchered its share price.
Bank Run Initiated
At this point, other Silicon Valley venture capitalists advised startups who bank with SVB to pull out, which is when the bank run started. In 24 hours, customer withdrawal amounts neared $42 billion, way too much of a spread for SVB reserves to cover. The Federal Deposit Insurance Corporation (FDIC) seized all SVB assets and promised that all bank deposits would be safeguarded and withdrawal requests honored. However, it is too early to tell if this move will be highly inflationary.
Online banking and digital transactions have vastly increased the speed at which money is transferable, increasing the chance of a bank run to happen faster as depositors can access their funds quicker than ever before. Digital banks should be required to hold liquid reserve cash to mitigate the risk of a run occurring faster because of electronic transfers.
How are Canadians affected by SVB?
By virtue of how regulated Canadian central banks are, it is unlikely that Canada will experience a direct contagion effect of the SVB collapse on our central institutions. However, the Canadian technology sector will feel immense pressure from this collapse, even for tech startups that weren't involved with SVB. SVB's failure will make it more difficult for Canadian startups to raise funding and could lead to large-scale layoffs in the sector, but only time will tell.
To conclude, the collapse of SVB was wholly unprecedented and signalled the start of what could be a disastrous contagion to the banking sector. Essentially, any institution overexposed to mortgage bonds is at risk of insolvency as further interest rate hikes will continue devaluing underlying bonds' mortgages. What is normally an extremely safe and stable investment for banks to hold is now falling apart. This could be the very thing needed to rebuild the financial sector and move away from an inflationary and debt-based monetary system.