Startup founder Lauren Humphrey first heard that Silicon Valley Bank (SVB) was in serious jeopardy around 5:30 am on Friday, March 10, while she was in Sydney. When the bank announced it would sell shares to raise capital after absorbing a $US1.8 billion ($2.7 billion) charge on the sale of some assets, SVB’s shares had dropped more than 60%. Humphrey was up early, nursing her two-month-old kid. She is the co-founder and CEO of The Mintable, a startup located in Sydney that creates solutions to teach people how to become better managers. “I was just aimlessly scrolling my email inbox and social media when I started to see some news fluttering about SVB. Our panic started to rise about the level of seriousness and the probability that the bank was actually going to collapse,” Humphrey says. “We had approximately 80 percent of our funding and revenues in the SVB bank and the remaining 20 per cent in CommBank here in Australia,” she added.
She began to freak out when she realised that her SVB funds “may or may not be available” in excess of the $250,000 insured by the Federal Deposit Insurance Corporation (FDIC). “Obviously, losing that money [in SVB] would be quite distressing,” she added. “The first thing that came to mind was, ‘Can we make payroll for the team based in the United States,’ … And then, ‘How can we stay in business? How much time do we have before our capital runs out?'”
The well-known Silicon Valley Bank (SVB), which serves startups and life-science companies, has managed to fail. It’s crucial to comprehend the bank’s operations and history before going into the causes of this failure.
Banks like SVB usually take in Short-term deposits. They later use the deposits to fund long-term investments. In addition to paying interest on deposits, banks seek greater returns on their long-term investments. Deposit interest rates may be higher than returns on long-term investments when central banks increase short-term interest rates. In that situation, the banks’ capital and earnings decline. To remain secure and functional, banks may need to obtain additional capital. In dire circumstances, some banks might fail.
Even a solvent bank may also fall if a huge number of depositors run to banks to take their money out all in a once. Amid such turbulent times, a bank lacks the liquidity to return anxious depositors with ready cash because banks invest their assets in long-term projects. Although bank runs are a common threat, they can be prevented in three ways. First, banks need to have adequate capital on hand to cover losses. Second, central banks should offer banks emergency liquidity in the event of a bank run to put an end to the panic. Lastly, depositors should feel at ease thanks to government deposit insurance.
A similar but rare bank run eventually took its toll on SVB, which the US government swiftly seized. In the instance of SVB, all three mechanisms might have failed. First off, it appears that SVB allowed its balance sheet to become seriously compromised and that regulators failed to act quickly enough. Second, US officials closed SVB rather than providing emergency central bank financing for unspecified reasons. Third, since Us deposit insurance only covered deposits up to $250,000, a run by big depositors was unabated. US officials declared they would guarantee all deposits after the run.
Future bank runs can be averted if central banks around the world give enough liquidity to institutions experiencing runs. For precisely this reason, Credit Suisse received a loan from the Swiss central bank. Recently, the Federal Reserve has increased its lending to American banks by $152 billion.
Yet, the efforts of the central banks to restrain inflation are somewhat countered by emergency loans. Uncertainty exists for central banks. By raising interest rates, they increase the likelihood of bank runs. But, inflationary pressures are likely to continue if interest rates are kept too low.
The central banks will attempt to strike a balance between higher interest rates and, if necessary, emergency liquidity. Although this is the best course of action, it has costs. With high prices and declining growth, the US and European economies were already experiencing stagflation. The banking crisis might push the US and Europe into a recession, escalating the stagflation.
A portion of the stagflation resulted from Covid-19, which forced central banks to inject enormous amounts of money in 2020, leading to inflation in 2022.
The Ukraine War, the US and EU sanctions against Russia, and escalating tensions between the US and China have all contributed to economic disruptions that have exacerbated the stagflation. These geopolitical factors have hampered output, affecting supply chains, driving up costs and prices, and upsetting the global economy.
Consumers and the financial markets have been uneasy due to the Silicon Valley Bank collapse’s effects on the larger banking system. SVB, a significant lender to startups and venture capital funds focusing on technology, put money into longer-term Treasury bonds, whose value has fallen due to Federal Reserve rate hikes. The issue arose when SVB could not satisfy its clients’ withdrawal requests, causing the bank to sell its Treasury bonds before maturity at a substantial loss. Lacking liquidity, SVB was forced to sell its assets at the wrong time in order to “absorb the shock of the cash run,” according to Braxton, a member of CNBC’s Financial Adviser Council.
He also pointed out that it’s a crucial lesson for investors who may one day experience their own cash crunch as a result of a job loss or another monetary emergency.
Author- Muhammad Mujtaba
