A few weeks ago, Goldman Sachs increased its prediction of a recession in the next 12 months to 35%. Infact, a survey conducted by the Wall Street Journal in January 2023 found that 61% of economists thought that the U.S would enter into a recession over the subsequent 12 months. A host of prominents banks, leaders and corporations have been living under the immense pessimism of a soon-to-come economic downfall. Silicon Valley Bank collapsing dramatically, followed shortly afterwards by Credit Suisse, is said to be the start of the financial mayhem everyone’s been betting on. Let’s take a look at how SVB collapsed to understand its significance on global economic sentiment.
Why did SVB Collapse ?
There were a number of factors that contributed to the downfall of the Silicon Valley Bank. One of the primary causes was the fact that the bank had become over-reliant on the technology industry. The sector has been continuously booming for the last 30 years, however it is also extremely volatile, leading to many failed investments. This volatile nature of the industry was again exponentially increased due to post-pandemic related economic downturns which negatively affected the tech industry as a whole due to unfulfilling optimism. This is also where the over reliance factor played in, as the question of “should we diversify our investments, as a way of ensuring the health of the bank?” was not raised internally.
Another factor that contributed to the bank's collapse was its aggressive lending practices. In an effort to compete with other banks, SVB had loosened its lending standards, offering loans to companies that were not financially stable or had questionable business models. This led to a large number of defaults, further exacerbating the bank's financial problems. Some critics have also argued that the bank had made “woke” investments and policies, as it accounted for nearly 62% of investments into community solar projects, while also pledging to increase diversity in the senior positions at the company.
The company also went without a Chief Risk Officer (CRO) for 8 months in 2022 leading to questions being raised and blame towards the management structure and policies when the bank eventually collapsed on March 10, 2023.
Systematic & Policy Faults
Some analysts have argued that the faults within the system are a cause of the collapse, not the bank itself. The federal government increased interest rates in 2022 and 2023 to combat inflation. This ultimately factored in the bank imploding because what the bank was essentially doing was taking money on short-term deposits and tying that money in long-term investments such as US Treasury Bonds.
The nature of these bonds is such that when the interests increase, the value of these bonds decrease and vice versa. This led to the company having to pay more to depositors without the financial security they enjoyed before, that again led to the company bleeding capital due to the increase in short-term interest rates, while having little to none short-term investments to provide an influx of cash within the bank. The spiral was again exemplified when people started to lose trust in the bank and started liquidating their deposits- feeding into the shortage of capital again and again, eventually leading to the bank's collapse.
The collapse of the Silicon Valley Bank had a significant impact on the technology industry, which had come to rely heavily on the bank for funding and support. Many startups and tech companies were left without access to capital, making it difficult for them to continue operating. Additionally, the collapse of the bank had a ripple effect on other financial institutions, examples being Signature Bank in New York and Credit Suisse in Switzerland. However, unlike 2008, the government wasn't trying to bailout the banks, the bank's peers were- with Biden not using any taxpayer money to help out SVB.
The role of social media in the collapse of the bank has also been brought into the spotlight. Many experienced and influential investors tweeted multiple times about their trust into the bank. This may or may not have fueled the existing depositors to liquidate their assets in the bank. In the past the role of social media has generally been associated with crypto markets, while the ‘traditional’ banking systems have been considered to be largely immune to the effects of social media. SVB may be a signal for traditional financial institutions to start taking into account the effects of social media, while discussing market policies.
Overall, the collapse of the Silicon Valley Bank serves as a cautionary tale about the dangers of over-reliance on a single industry and the importance of having proper financial policies and management in place. While the bank was once seen as a beacon of success in the banking industry, its downfall serves as a reminder that even the most successful institutions can fall victim to malpractices. As the banking industry continues to evolve and adapt to the relatively new technology industry, it will be important for both institutions and the government to keep this example in mind and work to prevent similar situations from occurring in the future.
By Tanish Shinde