The 48-hour closing break of the markets allows a respite to put some order on what happened to the Californian Silicon Valley bank, failed within 72 hours generating a wave of fear on the markets. The comparisons with Lehman Brothers they are not missed but look pretty out of place. The size of the crack is different, the genesis is different, the consequences are different. Hopefully. The company did not have particularly risky investments as was the case with the banks involved in the subprime mortgage crisis that exploded between 2007 and 2008.
THE GENESIS OF THE DISASTER – Let’s start from the beginning. Svb is a medium-sized Californian bank, specialized in the technology sector, with close ties to local businesses, one might say. Maybe even too much. In 2021 the pandemic broke out, activities and investments froze. Silicon Valley companies have a lot of money to put in their accounts, waiting for things to get going again. Svb deposits swell, in a year they increase by 130 billion dollars. At that time, US rates were still at zero and therefore deposits which, although somewhat counterintuitive for a bank, are liabilities, have practically no remuneration. The bank pays no interest. However, this money can be used to make loans (which, however, no one asks for at that stage) or can be invested. With a little more freedom than the big international banks which are subject to more stringent regulations. However, Svb does not make particularly risky choices. Indeed, it invests in what are considered among the safest financial products in the world, US government bonds. Precisely because they are so secure, the interest they pay is low (on average l’1,79% regarding the portfolio of Svb). However, since the bank does not pay interest on deposits, the operation is still profitable. So much so that Svb is included among the best banks in America by Forbes magazine.
In March 2022, however, things start to go wrong. In an effort to fight inflation, the Federal Reserve begins raising interest rates. Those manipulated by the Fed are the interests that banks pay to lend to each other in the very short term the money they have on deposit taken by the Fed itself but, in cascade, have more or less direct repercussions on any type of loan. Even on bank deposits which are money that businesses and households lend to banks, albeit with the condition that they can be withdrawn at any time and without notice. The cost of Svb deposits goes up like this from zero to over 2%. This happens also because the deposits with the bank are on average quite largelarge sums that give customers greater negotiating leverage on rates compared to small savers.
The business model thus it stops generating profits since government bonds continue to pay the same interest in absolute value. The bank starts posting losses. To get more interest you have to invest into slightly riskier assets. Nothing strange but if you divest you take home the losses and therefore, to manage the operation, you need money. The bank sells bonds for 21 billion dollars with a loss of 1.8 billion. A lot but not a lot if compared to the size of the institution. Svb therefore decides to turn to the market to raise new capital, issuing shares for just over two billion dollars. The answer though is glacial. Indeed, the move raises questions about the bank’s conditions and begins what has always been the nightmare of any credit institution, namely the bank run. Clients, although they are rather sophisticated investors in this case, move with the logic of the herd and all together start asking for their deposits back.
Questions at the counters within 24 hours exceed 40 billion. But SVB, like any other bank in the world, has only a fraction of the value of all deposits on hand (the money was used to buy the securities). It is a sum that is sufficient to manage ordinary administration, when withdrawals are offset by new deposits, but which quickly becomes insufficient if everyone decides to get their money back at the same time. The bank at this point has few options, either someone lends it money or it has to divest its assets. However, this takes longer and carries the risk of selling off and therefore forfeiting even greater losses. And off to the start in what is screwed into a deadly vicious circle.
At this point the US banking authorities move. Come into play there Federal Deposit Insurance Corp, the federal deposit insurance agency. As in Italy (and in Europe) deposits are in fact insured up to a certain amount, specifically up to 250 thousand dollars. But most of Svb’s bills exceed this sum, as many as 93% of deposits would be beyond the guarantee threshold. It does not mean that the money will be lost but to recover it, at least in part, it will be necessary to wait for the results of the liquidation procedures.
THE FALLS – Failure, also due to its speed, has spread fear on the markets. As it is fashionable to say these days “They didn’t see it coming” precisely because it is the result of different dynamics from the previous crises. European banks yesterday experienced substantial declines as American ones had done the day before. On the US market, sales hit above all smaller institutes with characteristics more similar to Svb as in the case of the Californian ones Signature Bank e First Republic Bank, PacWest Bancorp. The crack is undoubtedly emblematic of the tensions on bank balance sheets that can derive from rate hikes, in the US as well as in Europe. The fear of the markets is not so much about the fallout itself, the various exposures and links with other banks, but rather the resulting signal. The same dynamic, in a more or less serious form, could affect other credit institutions. Although in general the rise in interest rates tends to favor the profitability of banks, there are situations in which the repercussions are of the opposite sign, which evidently had not been correctly perceived up to now.
Robert Amstrong of the Financial Times however, he rightly pointed out the particularities of the Svb case. That is, a type of atypical clientele, with high average values of deposits, which translate into interest on deposits that are very sensitive to changes in interest rates and, conversely, an investment portfolio that is very little responsive to these same changes. For example, no Italian current account holder has noticed the rise in interest rates from his current account given that interest is stuck to zero. Another aspect to consider are the consequences that the bankruptcy will have on the Californian technology sector. Liquidating the bank’s assets will make it possible to recover a more or less substantial share of deposits but in the meantime that money is blocked. The deposits belonged mainly to start-ups and venture capital funds specializing in the high-tech sector, so there could be a temporary shortage of funds for the sector. Svb occupied a key role in supporting investments in the area, it has been defined as “a ventricle” of the Silicon Valley system.