by Kari Grenade, PhD, Caribbean Economist and Macroeconomic Advisor
On 10 March 2023, Silicon Valley Bank (SVB), the 16th largest bank in the US, primarily servicing technology start-up companies, collapsed, prompting intervention by the Federal Government.
SVB’s collapse is the second largest in US history and the largest since the global financial crisis of 2008.
Before delving into why SVB collapsed, it is important to explain how banks operate. In their simplest form, banks accept deposits and, in turn, make loans and investments with the deposits, earning the difference between the interest paid to depositors and the rate charged on loans and earned on investments, less any losses incurred on loans (if borrowers don’t repay) and on investments if they decline in value. Typically, all banks do not have the cash readily available should a large number of depositors simultaneously demand their deposits, in other words, should there be a run on the bank. It is important to point out that contemporary bank runs can occur electronically, in a few seconds, just by one or two clicks on a device and necessarily by depositors physically standing in long lines outside of a bank waiting to withdraw their money.
In the case of SVB, its deposits rose from US$49 billion in 2018 to US$189.2 billion in 2021, according to Forbes. In addition to making loans from those deposits, SVB also invested heavily in long-term US Government bonds when interest rates were low, thereby earning steady returns. However, when the US Central Bank (Federal Reserve or FED) started raising interest rates, the value of those bonds held by SVB declined. New bonds came into the market, attracting higher interest rates because of the FED’s rate hikes, and as such, the old or existing bonds became unattractive because newer government bonds paid more in interest. According to reports, SVB failed to make provisions for the possibility that interest rates would rise.
As interest rates rose, SVB’s clients, who were mainly technology start-ups began tapping into their deposits because their funding slowed as the technology bubble of the Covid-19 era burst. As SVB clients started making large withdrawals, the bank had to sell some of its assets to give money back to its depositors. However, in a bid to entice investors to buy its existing bonds at the lower interest rates, SVB had to reduce the price of those bonds, thereby making huge losses on its investments. Reports indicate that SVB lost US$2 billion on the sale of its existing bonds. Accordingly, the bank ran into a liquidity crisis and collapsed under the weight of its heavy losses and clients’ demands for their deposits. According to Forbes, only 3% of SVB’s deposits qualified for deposit insurance, hence the US Government’s intervention to protect SVB’s depositors.
In addition to the collapse of SVB, 2 other mid-sized US banks had to be rescued, and one relatively large European Bank (Credit Suisse) failed and was bought over by another. Despite the turmoil in the US banking sector, the US Finance minister (Treasury Secretary) has assured Congress that the US banking system remains sound and resilient. Indeed, thus far, the systemically-important banks in the US (JP Morgan Chase, Bank of America, Wells Fargo and Citi Group, for example) appear to be insulated from the turmoil. Nonetheless, the turbulence has shaken confidence in the US banking system and, to some extent, the global banking system, triggering uncomfortable memories of the 2008 global financial crisis. However, this time is different. The scale of the problem is less, affected banks are not systemically important as was the case in 2008, banks’ capital bases are stronger, and in the main, risk management is better than it was 15 years ago, given significant banking sector reforms since the 2008 crisis. This notwithstanding, there are still weaknesses that once again have been exposed and must be addressed.
The wider impacts and implications of the current turmoil are unclear at this stage. Those banks that have recently failed could be the first set of dominos to fall, or they could be one-off events that are contained, with little or no global implications. However, there is a risk that the turmoil in the US banking sector can cause banks to restrict lending at least for a while, which can result in a credit crunch, thereby increasing the risk of a recession in the US, with obvious global implications.
Possible implications for the banking and wider financial system in the Caribbean depend on whether and to what extent banks, credit unions, national insurance boards, insurance companies and pension funds had any direct and/or indirect exposure to the failed US banks and the extent of any unrealised or realised losses from their holdings of US securities. It is much too early to tell.
This is certainly an unfolding situation that will be monitored daily by economists and analysts across the Caribbean and across the globe. Let’s hope that the worst has passed.
What exactly is the point of this commentary? You more or less regurgitated what was already reported and repeated several times over.
I agree. I would have though that she would have highlighted the increasing risks that Caribbean banks are taking with depositors money invested in the USA. One of the top two Grenadian banks lost $37 million of depositors money on US investments last year. How much will they lose (again) this year?