Silicon Valley Bank has 30 years of glorious banking history & unexpectedly, we all see it has collapsed. The crash of Silicon Valley Bank raises some questions about US retail banking system. We know that a bank can collapse if they don’t deposit $250,000 in FDIC. If Silicon Valley Bank has deposit insurance, then why it collapses?
If you want to know why Silicon Valley Bank failed, you are in the right article. I hope you are not wasting your valuable time & find out some valid reason for Silicon Valley Bank’s collapse.
Let’s start with the following:
- Depositors withdraw huge cash from Silicon Valley Bank at once, which leads to collapse.
- Increase interest rate & losing bond investment also liable for Silicon Valley Bank collapse.
- Micro investing policy creates liquid money crisis for Silicon Valley Bank. Silicon Valley Bank failed because they didn’t consider macro investing policy.
- Poor loan management & neglecting accounting audit creates a long-term cash crisis for Silicon Valley Bank. Due to this mismanagement, Silicon Valley Bank could not manage liquid money to pay debts.
What is deposit insurance?
Deposit insurance is a monetary security cover to protect bank depositors during a liquidity crisis. It was formed in the USA to safeguard small unit banks.
Say, Chase bank fails because of meeting depositors’ needs. In this case, the US government provides financial protection to depositors of Chase bank.
How does deposit insurance work for a bank?
In the US, bank depositors normally have up to $250,000 as guaranteed money by The Federal Deposit Insurance Corporation (FDIC). This money is used to protect depositors if a bank fails to meet the current cash need of its depositors. Fund delivery time varies, but it usually occurs within 2 working days.
Imagine Citibank crashed due to mismanagement. Here, depositors will get back $250,000 within 2 working days by FDIC.
You may ask me, Silicon Valley Bank had deposit insurance of $250,000, then why does this insurance not save Silicon Valley Bank? Below is the answer:
Why $250,000 doesn’t save Silicon Valley Bank?
Most depositors withdraw money exceeding the $250,000 insurance deposit limit.
For example, the depositors of Silicon Valley Bank withdraw the maximum amount of cash within a short time. Silicon Valley Bank faces a liquidity crisis due to this quick withdrawal. They could not meet short-term obligations from current assets that damage the cash management system.
Think another way; you need $10 daily to meet your basic need. You also have a $10 backup on your credit card. Imagine you lost $20 or expenses more than your limit. Can a $10 credit card backup save you? No. You will face the same difficulty that Silicon Valley Bank has already faced.
Why did Silicon Valley Bank fail?
There are several reasons why Silicon Valley Bank fail. There are 8 strong reasons why Silicon Valley Bank collapsed.
Below is my analysis:
1. Balance sheet mismanagement:
The Silicon Valley Bank failed due to balance sheet mismanagement. The Silicon Valley Bank should make long-term investments when it found deposits exceed loan demand. Investing in multiple segment help bank get enough cash which assists in avoiding liquidity crisis. Therefore, Silicon Valley Bank should set its portfolio investment wisely.
Silicon Valley Bank chooses about $126 billion portfolio to invest in short-term only. Most banks maintain a diverse portfolio, but Silicon Valley Bank targets only short-term to make quick earnings. It could manage the crisis if Silicon Valley Bank distributes $126 billion into short-term, mid-term (medium profit), & some portion in long-term (for higher earning) assets.
Besides, Silicon Valley Bank invested about $100 billion in the mortgage. Are they not making the wrong investment decision?
2. Liquidity mismanagement:
Liquidity measures the ability of a bank to pay its short-term liabilities from current assets.
Usually, a bank needs to have $2 liquid money to pay a $1 short-term obligation. It also determines how quickly a bank can convert assets into cash to meet current dues.
In the case of Silicon Valley Bank, big depositors withdrew about $43 billion within two days due to the news of Silicon Valley Bank’s financial troubles. This $43 billion destroy the ability of Silicon Valley Bank to maintain a liquidity balance.
3. Silicon Valley Bank only focuses on start-ups & tech companies:
Bank should be operated by targeting the macro market, but Silicon Valley Bank target the micro market, i.e., only tech companies & start-up.
Start-up companies usually have huge cash balances that exceed the $250,000 limit. They do it often to achieve marketing goals. Venture capitalists also control these start-ups because of active engagement. This engagement creates a risk because if venture capitalists tell start-ups to withdraw all the money from Silicon Valley Bank, they force them to do very quickly.
4. Bond value decreased:
Silicon Valley Bank suffers from the huge bond interest rate. Due to increased interest rates, bond investment loses significant money, creating fears for investors. Due to a loss in government bond investment, many depositors and venture capitalists withdraw significant cash from Silicon Valley Bank.
So, the diminished bond & deposit crisis values combinedly crash Silicon Valley Bank.
5. Signaling theory:
Silicon Valley Bank kept most of the financial information inside & make limited financial health information available to its shareholders.
For example, Silicon Valley Bank issued $2.25 billion in stocks to raise capital but avoid financial losses. They spread the losses among stockholders & want to gain current cash benefits.
As a result, Silicon Valley Bank fails due to dividend irrelevance management.
6. Bad loan management:
Silicon Valley Bank makes too many loans to those borrowers who can’t refund credits.
As a result, this loan exceeds the FDIC limit & faces a significant liquidity crisis. They can’t balance their capital & reserves & ultimately insolvent to pay debts.
7. Careless risk management:
Bank provides financial security by taking depositor’s risk. Therefore, every bank has to focus on proper risk management measures.
Silicon Valley Bank didn’t care about risk factors but rather emphasized too much risky investment with poor risk management procedures.
So, weak risk management is also liable for the Silicon Valley Bank collapse.
8. Lack of regular audits and examinations:
An accounting audit helps the bank to reduce risk & suggests how to protect against reputational damage. Silicon Valley Bank doesn’t take it seriously & hide financial health report from investors. This lack of third-party audit is also liable to collapse Silicon Valley Bank.
Silicon Valley Bank (SVB) mainly serves technology & start-ups. Recently, lower share value, interest rates hike & changing consumer choices have impacted tech companies & start-ups. So, the Silicon Valley Bank crisis significantly damaged investors’ confidence and limited funding opportunity for venture capitalists. This crisis can destroy the long-term reputation of Silicon Valley for start-ups.
Therefore, Silicon Valley Bank will normalize to protect its long-term goodwill & also to save these industries. Now you may ask me how? Below are my predictions:
1. Rich banks will come forward & buy Silicon Valley Bank to protect depositors’ money.
2. FDIC will take necessary steps to pay SVB’s debt & all the investors will get back their money.
3. US government will come to bail out the uninsured deposits.
Frequently Asked Questions (FAQ):
Is Silicon Valley Bank collapse signal Federal Reserve to lower interest rate?
Yes, the Silicon Valley Bank crash force the Federal Reserve (The central bank of America) to think about interest hikes. If the interest rate reduces, it will be a positive signal for the stock market.
For example, US stock loses value due to increased interest rates. Most of the investors lost about half of their money. So, reducing interest rates can protect the stock market by adding value.
The information provided in this article is just the author’s view & only for educational purposes. By reading this, you agree that the information is not investment advice. Do your research before making any important financial decision. Therefore, FinanceIdeas.org will not be liable for your financial loss.