On March 12th, Signature Bank became the second major bank in the US to declare bankruptcy within a span of three days, following SVB's collapse, which was the second-largest bank failure in US history after Lehman Brothers' collapse in 2008. The financial industry is reeling from the shock of two major bank failures in such a short period of time, with the potential to impact not only the US but also the global economy. The timing of this financial crisis, just after the pandemic, could cause chaos for many people, undoing the progress made towards recovery.
Introduction to the Two Banks
SVB is a leading provider of banking services to venture capital firms and tech companies in Silicon Valley, with clients including major players like Apple, Google, and Facebook. With more than half of the US's sci-tech companies reportedly doing business with the bank, it has become a well-known name in the venture capital industry and among tech enterprises.
While Signature Bank is not directly related to SVB, it has also made a name for itself in the financial industry. Established in 2001, it provides private banking services to wealthy individuals and invests in cryptocurrency and Web3.0 industries. With its headquarters in New York, it is a smaller bank compared to SVB.
Unfortunately, both SVB and Signature Bank experienced financial collapse, with SVB's debt totaling $172 billion and only able to pay out 11% of its debt at the time of bankruptcy. Similarly, Signature Bank went bankrupt on March 12th, but the Federal Reserve responded by fully compensating all deposits using a special provision. To prevent further bank failures, a special financing channel was also established.
Reasons for Collapse
Starting in 2022, banks worldwide faced a significant challenge as interest rates increased. In the United States, the Federal Reserve began raising interest rates last year, and Malaysia followed suit. Since the Fed's initial rate hike on March 17th, 2022, interest rates have increased nine times in a year, reaching 5% from 0.25%. As a result, nearly all banks worldwide raised their interest rates, with the exception of Japan, whose Bank president feared significant economic impacts. Although raising interest rates may seem beneficial to some depositors, it is an unwelcome development for banks. The higher cost of borrowing leads to reduced borrowing and lower profits, while banks must pay more in interest to depositors, leading to financial losses. Consequently, most banks worldwide faced significant deficits from last year to this year. The Fed's decision to raise interest rates was intended to control inflation and rising prices.
What led to the surge in inflation? Two significant events took place. First, on February 24th, the Russia-Ukraine conflict erupted, disrupting global trade and logistics, which resulted in a global price hike, particularly in Europe and the US. The second event, which was less apparent but accelerated the price increase, was the relaxation of pandemic prevention and control measures. The US initiated pandemic control measures early last year, while Europe and the US lifted their measures relatively early, while Asia lifted them later. Japan still practices preventive measures, and many believe the pandemic isn't over yet. After the pandemic subsided, people returned to their daily routines, and demand for goods surged, such as tourism, shopping, and buying things. The Russia-Ukraine war caused a shortage of goods, while the lifting of pandemic prevention and control measures led to a surge in demand for goods, resulting in retaliatory consumption and inflation.
Last year, there was a significant increase in prices across various sectors in the United States. Fuel prices rose by 65.7%, egg prices by 49%, airfare by 36%, flour prices by 25%, and public transportation prices by 23.8%. Typically, it takes 5-10 years for prices to rise by 10%, but this increase occurred within a year. Unfortunately, most people's wages did not keep pace with the increase, leading to a decrease in real income and purchasing power. To prevent this from getting worse, the Fed raised interest rates, which could effectively reduce consumption and inflation by suppressing loans. Raising interest rates also encourages saving and reduces consumption. However, even with the Fed raising interest rates seven times last year, prices continued to rise. As a result, two more interest rate increases were made this year.
The primary customers of Silicon Valley Bank are investors and technology startups. During prosperous economic times, both groups earned substantial profits, resulting in a significant influx of funds into Silicon Valley Bank. As a bank, it invested these funds by lending money and investing in long-term assets, such as US Treasury bonds and mortgage-backed securities. However, these long-term assets have low liquidity, making it difficult to convert them into cash.
Despite this, Silicon Valley Bank was not concerned as it had been profitable for ten years without any economic upheaval, believing that most of the money would not be necessary to meet withdrawals. The bank only needed around 35% of liquid funds to cope with any potential situations. Unfortunately, in 2022, unexpected events occurred when the Federal Reserve raised interest rates. As a result, the 35% of funds earmarked for lending could no longer be utilized, causing the bank to pay significant interest to depositors without earning any profits.
Furthermore, raising interest rates also led to a decline in the value of long-term assets as high-interest rates deterred real estate purchases. Therefore, the increase in interest rates had a double negative effect on Silicon Valley Bank as the bank could not lend out cash, and the value of fixed assets diminished. It is not that the bank did not allocate assets professionally, but no one had foreseen the pandemic and the Russia-Ukraine conflict.
Financial Problem of SVB and Signature Bank
One reason why Silicon Valley Bank (SVB) and Signature Bank faced financial problems is due to their customer base. SVB primarily served venture capital firms, high net worth individuals, and start-up companies, while Signature Bank catered to wealthy clients. This means that both banks had fewer depositors, but each depositor had a substantial amount of money. In contrast, other banks of the same size, have a larger number of depositors with smaller amounts of money, which spreads the risk.
For example, let's consider Bank A and Bank B. Both banks have the same amount of deposits, but Bank A has 100 depositors who each have $10,000, totaling $1 million, while Bank B has only one depositor who is a high net worth individual with $1 million. If the high net worth individual withdraws their money from Bank B, the bank could go bankrupt. In contrast, if a few depositors want to withdraw their money from Bank A, the bank could still survive as it has more depositors to rely on.
Similarly, when depositors of SVB and Signature Bank wanted to withdraw their money, the banks did not have enough cash to give them because a significant portion of their assets were invested in long-term assets such as government bonds and real estate. These assets cannot be easily sold, which further exacerbated the liquidity problem. Therefore, banks with a concentrated customer base and investments in illiquid assets are at higher risk of financial collapse.
Why did customers withdraw their money?
In fact, since the second half of last year, we have seen a lot of news about layoffs on TV, such as Facebook, Amazon, Google, Twitter, and so on. These are mostly technology companies, including SVB's customers who were primarily start-up companies. As these companies faced economic difficulties, they withdrew their money from SVB to weather the storm. However, SVB had invested most of its assets in illiquid long-term assets such as government bonds and real estate, and had very little cash on hand. As a result, when depositors began withdrawing their money, the bank quickly ran out of cash and was forced to sell off some of its long-term assets to meet withdrawal demands. This led to a panic among other depositors who feared the bank was near bankruptcy and also began withdrawing their money. On the day before the bank's collapse, customers withdrew $43 billion, which was equivalent to 25% of the bank's total assets.
In summary, the collapse of SVB was the result of a chain reaction that began with the end of the epidemic and the Russo-Ukrainian War. These events led to rapid price increases and inflation, which forced the FED to raise interest rates to suppress prices. This created difficulties for venture capital firms and start-up companies that relied on loans, leading to layoffs and withdrawals of funds. SVB was particularly vulnerable as its customers were primarily start-up companies and venture capital firms, and the bank had invested heavily in illiquid long-term assets. This made it difficult for the bank to meet the withdrawal demands of its depositors, leading to a run on the bank and its eventual collapse.
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