The Silicon Valley Bank Crash, Contagion, and Containment

The collapse of Silicon Valley Bank (SVB) sent shockwaves through the global economy. The collapse of SVB, the parent bank focused on tech start-ups, announced on Friday, March 10, is the biggest since the 2008 financial crisis.

Just over a year ago, Silicon Valley Bank held more than $200 billion in assets and was known as the leading bank in the venture capital industry. But what is the reason for the collapse of SVB, and will it trigger a domino effect in the global economy?

Soaring VC funding and net interest margins

Venture capital funding levels surged between 2019 and 2021, meaning start-ups received huge amounts of cash, which they then deposited with Silicon Valley Bank, which at this point has been around for over 40 years and is widely considered the most-watched bank One of the stable and trusted start-up and venture capital banks. According to Morning Brew, deposits at SVB have risen from about $60 billion in 2018 to $189 billion in 2022.

But banks also need to be profitable. The rise in deposits presents an opportunity for SVB to make money through what it calls “net interest margin”.

Net interest margin is a common way banks generate income. They offer low interest rates on savings accounts, then invest that money in different forms of investments that offer higher returns, and take the difference as their profit.

SVB owned all those deposits, and to generate a return (at a time when interest rates were still almost 0%), they reportedly put $80 million of the $189 billion into long-term mortgage-backed securities. The securities reportedly yield around 1.5%, giving SVB a healthy net interest margin.

Silicon Valley Bank Collapse, Contagion and Containment

Silicon Valley Bank offices in Tempe, Arizona. Source: Flickr

liquidity crisis

However, the bank’s reliance on long-term mortgage-backed securities to generate deposit returns poses potential risks for the bank. The securities are long-term liabilities used to secure short-term deposits bought when interest rates were at historic lows. The move has helped SVB maintain a healthy net interest margin, but it also creates risks for the bank when federal interest rates rise to at least 4.5% from near zero a year ago.

The bank’s negligent risk management, combined with macroeconomic factors and rumours, triggered a run on bank deposits. As word spread that the bank might fail, customers began withdrawing their deposits, creating a liquidity crisis for the bank. The stock had plunged 60% as of Thursday last week and was suspended after falling another 69% on Friday. By noon Friday, regulators shut down SVB, the Federal Deposit Insurance Corporation (FDIC) took over its affiliates, and it was officially out of business.

Implications for fintech, cryptocurrencies and the global economy

The collapse of SVB had a major impact on the global economy, especially on the tech and startup ecosystem. The bank is an important platform for startups and plays a pivotal role in serving the startup community and supporting America’s innovation economy. Many start-ups had deposits with SVB, and the bank’s collapse created uncertainty for the start-up ecosystem.

The impact of SVB’s collapse is not limited to the US, with financial institutions and fintech companies in the UK, Canada, Singapore, India, Hong Kong and China feeling the impact. In India, fintech and venture capital firms such as Recur Club, Razorpay and Trifecta Capital have offered aid to Indian startups caught in the crossfire of the Silicon Valley Bank fiasco. The companies are offering support to affected startups, a move seen as a sign of solidarity within the global startup ecosystem.

At least 11 Hong Kong startups, mostly biotech firms, have been affected and the Hong Kong Monetary Authority (HKMA) said they were monitoring the situation. Investment banks from China and Japan, including Shanghai Pudong Development Co Ltd, SoftBank Group Corp’s SoftBank Vision Fund and Sumitomo Mitsui Trust Holdings, all have varying degrees of interest in SVB.

The Silicon Valley Bank Crash, Contagion, and Containment

The Silicon Valley office of the SoftBank Vision Fund.Source: Wikimedia Commons

SVB’s UK unit declared bankruptcy shortly after appeasing depositors on Saturday, but has since been bought by HSBC for a pound. In Australia, accounting software fintech Xero Ltd. said it has about A$5 million ($3.3 million) in exposure to SVB US and the UK, where it has transaction banking relationships.

Two crypto-friendly banks, Silvergate and Signature Bank, were also liquidated this past weekend in an effort to stem the contagion of the banking crisis. Depositors at both SVB and Signature have since been assured that regulators have full access to their deposits.

A number of lender fintechs, including Revolut and Wise, reported a surge in interest in their deposit products as startup founders and investors liquidated their SVB holdings. Meanwhile, Circle’s $3.3 billion USDC stablecoin reserve deposits held at Silicon Valley Bank (approximately 8% of total USDC reserves) will be fully available when Bank of America opens its doors on Monday, March 13th morning. Signature Bank does not hold USDC cash reserves. USDC is still redeemable 1:1 with U.S. dollars as a regulated payment token, according to a statement from Circle.

Regulatory Price Correction

The collapse of SVB has also raised questions about the regulation of banks and financial institutions. The California Department of Financial Protection and Innovation closed the SVB and designated the FDIC as the recipient. The FDIC created the Santa Clara Deposit Insurance National Bank, which now holds SVB’s insured deposits. The collapse of SVB highlights the need for increased regulation to prevent such incidents from happening in the future.

The Silicon Valley Bank Crash, Contagion, and Containment

Sealed office in Santa Clara, California.Source: Wikimedia Commons

The Federal Reserve announced that it will provide additional funding to eligible depository institutions to help ensure banks have the capacity to meet the needs of all depositors. Additional funding will be provided through the creation of a new Bank Term Financing Program (BTFP), which provides loans for up to one year to banks, savings associations, credit unions and other eligible depository institutions.

The institutions will pledge U.S. Treasury bonds, agency debt, mortgage-backed securities and other eligible assets as collateral. These assets will be valued at face value. BTFP will be an additional source of liquidity for high-quality securities, eliminating the need for institutions to quickly sell these securities in times of stress.

The Fed’s move is aimed at preventing a repeat of the liquidity crisis that led to the collapse of SVB. By providing additional funds to eligible depository institutions, the Fed seeks to ensure that banks have the capacity to meet the needs of all depositors. The move is seen as a proactive measure taken by the Federal Reserve to prevent the spread of the aftermath of the Silicon Valley bank failure.

Featured Image Credit: Edited from Unsplash

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Source of information: Compiled from FINTECHNEWS by 0x Information.Copyright belongs to the author Johanan Devanesan, without permission, may not be reproduced

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