US Banking Crisis Explained!
What Silicon Valley Bank Do?
- Silicon Valley Bank (SVB) is a California-based startup funding bank running since 1983 that lends to early-stage technology and biotech startups, and manages funds of venture capitalists, HNI founders.
- Bank lend money to new startups and also accept the deposit from venture capitalists and HNIs.
- The SVB Bank was a $212bn tech-lender and was 16th largest bank in America.
Mechanism of Bonds and Fed rate!
- This is the rate at which commercial banks borrow and lend their excess reserves to each other overnight.
- Central Banks make changes in interest rate to manage inflation and liquidity.
- In the times of Covid crisis where all the economic activities were stopped, production has been on halt and demand collapsed.
- Federal reserve decreased the interest rate to 0 to 0.25% to infuse liquidity in the system to revive the economy from the bad situation.
- But the easy money available in the system cause the higher inflation in the US, inflation reached at 7.9% which was at 40-Year High.
Why Bank fail?
- Banks fail as they lend long term, whereas, their deposits are short term. They cannot call back their long-term loans easily, whereas their short-term deposits have to be paid on demand.
- One of the funds run by leading VC Peter Thiel had asked to withdraw deposits from SVB. On the same day, the bank clarified that it had sold government bonds to shore up its capital base.
- They invested their deposit in US Government bonds when fed rate was at 0 to 0.25%
- And as Interest rate rises over 4.75% in a year, they incurred loss of 1.8 billion dollar, sold 21 billion dollar bonds to pay to depositors.
- They announced to raise $2.25 billion by selling a mix of common and preferred stock which lead to fall of 60% in price of stock
Important: But as interest rates climbed, investors were more interested in new bonds that promised to pay more, and long-term bonds tied to older, lower rates, became less desirable and therefore less valuable.
Ripple Effect
- Global banking has been in turmoil over the last two weeks following a series of stunning bank collapses in Europe and the United States.
- The first bank to collapse was Silvergate Capital Corp, the US’s first bank to go down due to the downturn in the crypto industry.
- Signature Bank faced a crisis on March 12 when investors started withdrawing large amounts of money anticipating a crisis in the banking sector, causing the bank to run out of money.
- Credit Suisse nearly 167-year run came to an abrupt end Sunday when its larger and longtime rival UBS Group agreed to buy it, marking the biggest deal in the global banking system in years.
- UBS agreed to pay Credit Suisse shareholders 3 billion Swiss francs, or around $3.1 billion, in the all-share deal.
- First Republic Bank also fell prey to the withdrawal of large numbers of customers’ money. The bank’s cash flow has been estimated at $89 billion, and $30 billion in cash was given to save it, but its shares are still falling.
Learnings!
Banking is said to be the backbone of any economy as it has a direct bearing with financial and economic development, economic development becomes faster if the banking sector is stronger and efficient.
Lessons for Different party
- For Depositors- You should not put your hard earned money in only one bank, as the bank deposits in India are insured by the deposit insurance and credit guarantee corporation (DICGC) up to an amount of Rs. 5 Lakh per customer/depositor.
So, It is advisable that depositors keep their deposits in different bank account to get insurance of Rs. 5 lakh each in different banks.
2. For Investors- As an Investor in the banks one should check the asset-liability scenario, cash-in-hand, concentrated deposits and source of deposits and management and corporate governance.
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