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A Tradition Of Bank Runs: Understanding the Silicon Valley Bank Crisis.

Failure of SVB In 2000s

A US-based bank called Silicon Valley Bank (SVB) primarily serves the needs of the technology and venture capital sectors. SVB went through a crisis in the early 2000s as a result of its exposure to the dot-com bubble. The bank experienced huge losses as a number of its clients stopped making loan payments, which caused a steep fall in its profits.

The dot-com bubble bursted in 2001, which is when SVB's problems started. The bank had granted large loans to IT entrepreneurs, who were suddenly unable to pay back their debts. The bank's loan portfolio rapidly declined, and the percentage of non-performing loans shot up. SVB was required to write off a substantial amount of its loans, which had a negative impact on both its revenue and profitability.

Due to the crisis, SVB was compelled to make significant changes to lower its risk exposure. The bank focused on its main business of offering banking services to the technology and venture capital sectors while tightening lending requirements, reducing its loan portfolio, and reducing risk exposure. For the purpose of bolstering its balance sheet, the bank also raised more capital.

SVB developed into a stronger and more specialised bank as a result of its ability to successfully recover from the crisis. As a result of the bank's continued client growth and expansion into new markets, it is today considered as one of the leading financial institutions catering to the US venture capital and technology industries.

The Silicon Valley Bank crisis has brought to light how crucial it is for banks to diversify their loan portfolios and follow good risk management procedures. Banks that focus on a specific area or industry are more susceptible to economic shocks and downturns in that sector. As a result, it is crucial for banks to keep a balanced portfolio of loans and to constantly track their risk exposure.

SVB 2023 Failure

One of the oldest causes of bank failure—SVB failed for this reason. Demand deposit money was raised, and the funds were then invested in longer-term assets, resulting in the classic liquidity mismatch. All banks operate in this manner, and it is the responsibility of the regulators and risk management of the banks to reduce the threat posed by this mismatch.

A traditional bank run occurs when all of the bank's customers want to withdraw their money from the institution at the same time. Of course, this procedure is well-known from the global financial crisis, not the least of which being the October 2007 Northern Rock bank run. SVB was the 16th largest bank in the US and the second greatest bank failure in US history. It had grown incredibly quickly, with total assets nearly doubling from $116 billion at the end of 2021 to $216 billion by the end of 2022.

SVB gave the impression that it was taking precautions by placing deposits in US government bonds, a sort of investment with little credit risk given the likelihood that the US government won't default on its debt. These bonds were deemed completely safe by US regulators. Governments frequently instruct banks to treat their own sovereign debt as risk-free for the purposes of credit. Even after Greece's government went into debt ten years ago, European regulators insisted banks see Greek government bonds as risk-free investments. This benefits the government financially and decreases interest rates on new government bonds, which is one explanation.

The risk SVB faced was not default but rising interest rates. It purchased its bonds during a period of prolonged, extremely low interest rates. With the best of intentions to boost the economy and help the world recover from the 2008 financial crisis, the US Federal Reserve set these low interest rate levels. It wasn't the only one doing it. Global central banks, including those in the UK, followed suit. Sadly, the low interest rate strategy resulted in new categories of risk that the central banks did not fully recognise during the process. Companies soon got dependent on low interest rates as a result of their adaptation to the low rates, making it difficult for them to survive when the rates rose.

The value of SVB's bonds decreased when the Fed substantially increased interest rates to combat inflation. Unexpectedly, no one seemed really concerned. Instead of realising losses and reducing positions, SVB management decided to buy more bonds. Regulators approved of it. Most of the rich tech businesses, venture capital firms, and management teams that make up SVB's depositors have enough opportunity to appropriately assess the risk that SVB faces from its frequent accounting disclosures.

So, it is especially infuriating that the tech companies in the UK that were banking with the SVB branch in London demanded a government bailout. Because extremely affluent people requested bailouts, the government had to divert funds from social programmes like the NHS to their bank accounts. With regard to the societal consequences of government financial policy during the 2008 financial crisis and how this fueled populist rhetoric, what is particularly alarming is the irresponsible language the Chancellor of the Exchequer employed on bailing out SVB.

Luckily, SVB's specific weaknesses are not shared by many other institutions. It put the majority of its assets in government bonds and had a small base of deposits. Notwithstanding SVB's distinctive qualities, its loss serves as a reminder that the financial system is less stable than we would like. After 2008, the financial authorities assured us that a recurrence would not occur, that financial regulations would safeguard us, and that bailouts would not be necessary. Nonetheless, here we are in 2023 with the US government helping SVB depositors, the UK government feeling compelled to finance the sale of SVB's UK subsidiary, and a sizable portion of global banks suffering losses on government bond holdings. There is no stability in this recipe.

The SVB crisis shows that the post-2008 financial policy, including rules and monetary policy, failed. Long-term low interest rates followed by quick rate increases served as adequate notification that banks with sizable bond exposure were in danger. It seems, nevertheless, that up until recently, management and regulators were not sufficiently alarmed. The financial authorities are in an awkward circumstance. The effect from SVB's failure has been minimised, but it also highlighted how many banks are susceptible to rising interest rates. To combat inflation, which threatens financial stability, central banks must maintain high interest rates or raise them. Governments have less room to respond to a crisis since their fiscal positions are substantially worse now than they were in 2008. It is virtually hard to combat a crisis by printing money, like we did in 2008, due to the high inflation rate. Furthermore, while political resistance to bailouts was not as strong as it was in 2008, any bailouts would encourage political radicalism in the present.

The loss of SVB shows us that the financial system is far more vulnerable than the general people had been led to think, even though it is doubtful that it will cause a crisis. The most likely result of its failure is that regulators will scrutinise banks more closely, raising lending costs and hurting the economy. SVB ultimately proves how challenging it is to maintain financial stability through risk management. The financial authorities can never completely eliminate risk, so we are left with a homogeneous and expensive banking system that harms the economy and raises systemic risk.

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