Silicon Valley Bank Explained

Who is Silicon Valley Bank?
Silicon Valley Bank largely banked start-ups and venture companies and was never a big lender. The start-up would get its seed capital and put it into Silicon Valley Bank. Silicon Valley Bank would take the deposits and largely invest in securities like Treasuries to capture a yield. If held, these don’t impact the bank’s capital and liquidity, as the unrealized losses go away as the bonds mature. Problems arise when assets in the investment portfolio must be sold because it then crystallizes the loss, impairing capital.

What went wrong?
As venture activity slowed last year, the start-ups, not getting additional financing, had to draw on their deposits faster. They were causing the Silicon Valley Bank to act on their bonds and term deposits before maturity realizing losses. This causes some concern for investors in Silicon Valley Bank, Causing a Bank run.

The banking system is highly dependent on customer confidence. All bank deposits in the U.S. are insured by the Federal Deposit Insurance Corporation (FDIC), but only up to $250,000 (a similar insurance system exists in Canada under the CDIC). Deposits above that cap are uninsured. Bank customers have no upside of staying with a bank that is rumoured to have problems, especially if their deposits at the bank are above the FDIC cap. This creates a strong incentive for depositors to move their capital to an institution that is perceived as safer, which amplifies the problems of the institution they are departing from.

Will other banks be affected?
Silicon Valley Bank’s client base and operations differed from other U.S. banks, including smaller regional banks. Because most of its accounts were venture capitalists and tech startups, over 90% of its deposit accounts were above the FDIC cap. Moreover, Silicon Valley Bank had one of the biggest investment portfolios relative to its capital base. All this makes it likely that the bank’s problems are localized.

What does this mean going forward?
Stress appearing in the banking system is unsuitable for risk sentiment, even if it is limited solely to Silicon Valley Bank. On the flip side, it will appear on the Fed’s radar as they consider the next step on the monetary policy front and probably reduces the likelihood that they will aggressively hike rates from here. That is what makes markets difficult: there are a lot of intertwined dynamics. The best way to account for risk is to invest in a Globally diversified approach. Therefore, you are not overly exposed to risk in one individual industry or country.

 

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