Banking collapse: the downfall of Silicon Valley Bank in 2023 & more
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More Cliff than Valley: The SVB Collapse
One of the most prominent lenders in the world of technology start-ups collapsed on March 10, forcing the U.S. government to step in.
In this article, we will discuss what led to a big lender to American startups going under, what the biggest bank collapses are by value and market share, the asset classes that were positively and negatively affected, and how to identify contagion in the financial system.
The Downfall of Silicon Valley Bank
Slowly, then suddenly: with nearly $200 billion in assets, Silicon Valley Bank (SVB), the 16th-largest lender in America, has failed. Over time, its financial situation got worse, but it took only two days between the San Francisco-based bank's March 8 disclosure that it was looking to raise $2.5 billion to close a hole in its balance sheet and the notification that SVB had collapsed by the Federal Deposit Insurance Corporation, which oversees deposits in American banks.
A brief history of SVB
It has been a thriving financial institution that specialises in providing banking services to technology and life science companies, venture capitalists, and private equity firms. Founded in 1983, SVB is headquartered in Santa Clara, California, and has branches and offices in several locations around the world. It was considered one of the top banks for startups and innovative businesses, and has been instrumental in helping many companies in the tech industry grow and succeed.
Previous bank failures in the US
Over the past century, there have been several major bank collapses that have had far-reaching impacts on the global financial system. From the first collapse of Silicon Valley Bank in 1983 to Lehman Brothers in 2008 to the nationalisation of Banco Espirito Santo in 2014, these failures have highlighted the interconnectedness of the financial system and the need for effective risk management strategies.
Fail. Crash. Collapse.
On March 8, 2023, following a bank run that compelled the California lender to sell some of its debt instruments, Silvergate Capital, a bank that focuses on cryptocurrencies, declared it would close its doors and liquidate its assets.
Investors expressed alarm when SVB stated that it needed to strengthen its balance sheet and raise $2 billion in capital. It was obliged to sell a portfolio of bonds at a loss of $1.8 billion.The bank's bond rating was reduced by credit rating agency Moody's, and its outlook was changed from stable to negative.
This is how one of the most well-known lenders in the startup community, Silicon Valley Bank, failed. In order to calm concerns and reduce risk in the larger financial system, federal regulators intervened.
Implications for the financial sector
- Silicon Valley Bank’s collapse led to the failure of a second bank and prompted regulators to move to contain the fallout in the U.S. banking system.
- Ambition and Management Errors: Although Gregory Becker, the CEO of Silicon Valley Bank, praised technological advancement, the organisation was caught off guard by economic change.
- The Cost of Silicon Valley: The incident exposed the weaknesses of the tech sector, despite assurances from the government that depositors would be able to retrieve their money from Silicon Valley Bank.
- Federal probe reportedly launched by the Justice Department investigating the failure of Silicon Valley Bank. The focus, according to legal experts, may be on insider sales made by numerous bank executives in the weeks prior to the disaster.
Potential implications for the Fed's rate-hike cycle
The key question right now is whether the collapse of SVB and the creation of the BTFP mark the "breaking point" for this Fed cycle. Because if so, it has implications for the valuation of all assets, including stocks.
Let’s take a look at some of the biggest bank collapses by…
1.) Value
The collapse of Lehman Brothers in 2008 remains the largest bankruptcy in U.S. history, with an estimated value of over $600 billion. The failure of the bank, which was heavily invested in subprime mortgages, had far-reaching impacts on the global financial system and led to a widespread credit crunch.
Other major bank collapses by value include the collapse of BCCI in 1991, which resulted in a loss of billions of dollars for investors and depositors, and the collapse of Continental Illinois National Bank and Trust Company in 1984, which required a government bailout.
2.) Market share
In addition to their value, the market share of a bank can also have significant impacts on the financial system.
For example, the Royal Bank of Scotland (RBS) was the largest bank failure in history by market capitalization, with a market share of over 5% in the UK. RBS required a £45 billion bailout from the UK government after facing significant losses due to the financial crisis.
Other major bank failures by market share include Bankia in Spain and Dexia in Belgium-France. Both banks required government bailouts after significant losses in the Greek and Italian sovereign debt markets.
Who made money from bank collapses?
While many investors suffered significant losses during these bank collapses, there were also those who were able to profit from the instability in the markets. Other investors were able to take advantage of the distressed prices of bank stocks and other assets, buying low and selling high as the markets recovered.
Did you know? Short seller and hedge fund manager John Paulson famously made billions of dollars by betting against the housing market leading up to the 2008 financial crisis.
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Which asset classes were negatively affected by bank collapses?
The financial and real estate sectors were hit particularly hard by the bank collapses, leading to significant losses for investors. Bank stocks, such as those of Lehman Brothers and RBS, plummeted in value as the financial crisis took hold.
Real estate stocks and other related assets, such as mortgage-backed securities, also suffered significant losses.
For example, the collapse of the U.S. housing market had significant impacts on the broader economy and led to widespread losses for investors in mortgage-backed securities.
Many asset classes were hit hard by the 2008 financial crisis. Stocks, commodities, and real estate all suffered significant losses in the short term. However, many of these asset classes bounced back relatively quickly. By early 2009, stocks had begun a strong recovery that continued for several years, with the SPX500 index more than doubling in value by the end of 2013.
Similarly, commodities such as oil and gold, which had seen steep declines in the wake of the crisis, bounced back in the years that followed. Real estate, which had been hit hard by the subprime mortgage crisis, also began to recover in the years after 2008, although the recovery was slower and more uneven than that of other asset classes.
In addition to stocks and real estate, high-yield corporate bonds also suffered in the aftermath of the financial crisis. However, like other asset classes, they rebounded quickly. By 2009, high-yield bond funds had rebounded from their lows and continued to perform well in the years that followed.
The positively affected asset classes
During times of financial uncertainty, investors often turn to safe-haven assets such as gold and government bonds.
For example, the SPDR Gold Shares ETF, which tracks the price of gold, saw significant gains during the financial crisis as investors sought out safe investments. Similarly, U.S. Treasury bonds are often considered a safe-haven asset and may increase in value during times of market turmoil.
Defensive stocks, such as Johnson & Johnson and Procter & Gamble, also performed relatively well during the financial crisis. These companies are considered less sensitive to economic cycles and may perform better during market downturns. Both J&J and P&G have significant investments in biotech companies, many of which have their deposits at Silicon Valley Bank.
How to identify contagion
Contagion refers to the spread of financial instability from one sector or institution to another, and it can have significant impacts on the broader financial system. Identifying contagion early on is key to mitigating its impacts and preventing a widespread financial crisis.
- One way to identify contagion is to monitor interbank lending rates. When banks are reluctant to lend to each other, it can indicate a lack of trust and confidence in the financial system.
- Credit default swap spreads can also be an indicator of contagion. Credit default swaps are essentially insurance contracts that protect investors against the default of a bond or other debt instrument. When the spreads on credit default swaps widen, it can indicate increased risk in the markets
- In addition, monitoring the performance of specific asset classes and instruments can provide insight into the health of the financial system. For example, if a particular sector, such as real estate or technology, is experiencing significant losses, it could be an early warning sign of wider contagion.
Conclusion:
The bank collapses of the past century have highlighted the importance of effective risk management and the need for vigilance in monitoring the financial system. While these failures had significant impacts on the global economy, they also provide important lessons for investors and policymakers.
Investors can protect themselves from financial instability by diversifying their portfolios and investing in safe-haven assets during times of market uncertainty. Policymakers can mitigate the impacts of contagion by implementing effective regulation and oversight of the financial system.
By staying vigilant and responsive to warning signs of financial instability, investors and policymakers can help ensure a stable and resilient financial system for years to come.
Not investment advice. Past performance does not guarantee or predict future performance.
