By Richard Warr
On March 10, the nation’s top bank regulator, the FDIC took over control of the failing Silicon Valley Bank, resulting in the second largest (by assets) bank failure in US history.
Silicon Valley Bank was unusual in that it specialized in lending money to tech and biopharma start up companies. Like typical banks, it funded these loans by taking deposits, however unlike typical banks, many of these deposits were very large and came from cash rich tech firms. In order to generate a decent return for these deposits, the bank chose to invest its depositor’s money in secure long term Treasury bonds. These securities, issued by the Federal Government, are very low risk and paid a slightly higher interest rate than comparable short term investments.
All was well, until recently when the Federal Reserve started raising interest rates significantly. This increase in interest rates put pressure on the bank to provide better rates of return to its depositors, but unfortunately, it was locked into the long-term low-interest Treasury Bonds. Depositors started withdrawing funds, in search of higher interest rates, which forced the bank to sell some of its Treasury bonds at a loss (bonds fall in value when interest rates increase).
Pretty quickly, the bank started to face a liquidity crisis, which occurs when depositors withdraw their money and the bank can’t cover the withdrawals. The bank recognized that it needed to raise more money, so it filed with the Securities Exchange Commission (SEC) to raise funds to pay its depositors. Unfortunately, the depositors viewed the fundraising action as further evidence that the bank was insolvent and they rushed to withdraw their money. What resulted was a “run on the bank”, the same situation that occurred in the classic movie “It’s a wonderful life”.
Over the weekend, the FDIC took over control of the bank and guaranteed that all depositors would get their money back. This support was provided despite the fact that many deposits exceeded the $250,000 FDIC deposit guarantee. The regulators were sending a clear signal that there was no need to panic.
It’s worth noting that the Silicon Valley Bank collapse wasn’t caused by risky investments or fraud, but by the bank simply not anticipating the effect of locking its depositors’ money into relatively low interest rate securities.
For now, the deposits of Silicon Valley Bank are safe, but the concern facing the economy is whether this failure will cause contagion across the banking system. On Sunday another bank, Signature Bank in New York, was taken over by regulators on Sunday after a run occurred.
For consumers, there is no real reason to panic. All deposits up to $250,000 are guaranteed by FDIC by deposit insurance, so if you are banking with an FDIC-insured bank, your deposits are safe. A similar guarantee program exists for Credit Unions. The biggest short term losers from this situation are likely to be investors who hold stock in struggling and failed banks. The investors in both Silicon Valley Bank and Signature Bank are likely to lose most, if not all of their stock investment.
The actions of the FDIC and other regulators over the coming days will be crucial in stabilizing this rapidly evolving situation.
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