Investment Risk Management: The Collapse of Silicon Valley Bank and Its Impact on the Banking Industry
The collapse of Silicon Valley Bank, the second-largest bank failure in American history, has caused anxiety to spread throughout the banking industry. After a period of rapid deposit growth, the bank was forced to sell bonds at a loss to raise cash to meet redemptions and attempted to issue additional shares to shore up capital. Unfortunately, this was not enough, and a full-fledged bank run ensued.
At the heart of the issue was how Silicon Valley Bank invested its customers’ deposits. The bank purchased long-duration bonds, yielding an average of 1.56%. Of these bonds, 97% had a maturity date of ten years or more, and 56% were fixed-rate. This decision to invest most of its deposits in fixed long-term bonds indicated SVB assumed interest rates would stay near zero for the next decade. The Federal Reserve, however, had already begun to hike rates, causing the value of these bonds to plummet.
To make matters worse, SVB’s loan portfolio was also generating low returns of well under 4% after provisions for credit losses. This combination of low-yielding fixed-rate investments, high deposits, and low-yielding loans left the bank in a precarious position.
The Federal Deposit Insurance Corporation (FDIC) has now taken control of SVB and agreed to guarantee all of its deposits beyond the usual $250,000 limit. Investors are pricing in a 76% chance the Fed raises rates by just 25 basis-points next week, and a 24% chance it pauses rate hikes altogether. This is likely in response to the events surrounding SVB, as the Fed is likely attempting to navigate a delicate balance between curbing inflation and ensuring financial stability.
The collapse of SVB has bred “apocalyptic” fears in markets, but according to Nobel economist Paul Krugman, almost none of the most commonly voiced fears are correct. While some are worried that the rescue of SVB could lead to a moral hazard dilemma for bankers, Krugman argues that the opposite is true: insuring all depositors could actually increase risk moderation.
Overall, the collapse of SVB serves as a warning to banks and depositors alike. It is a reminder to ensure deposits are spread out across multiple banks and that banks are diversifying their investments and managing risk appropriately.
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