Updated: Apr 2
After the failure of SVB Financial Group (SIVB.O) and Signature Bank (SBNY.O) this week, U.S. authorities announced exceptional steps on Sunday, providing a safety net to banks under pressure from depositors who are making a break for it. President Joseph Biden promised to take steps to protect the financial sector on Monday.
SVB’s Free Fall - What does it mean?
The fall of the Silicon Valley Bank has become the largest bank to fail since the 2008 financial crisis. For decades it has been funding start-ups and was thus cash rich, however due to its short sightedness in buying billions of dollars of Treasury bonds it was hit hard by aggressive strategies adopted by the Federal Reserve to raise interest rates in order to fight inflation. However not all of its issues can be attributed to interest rates. The bank had certain distinctive qualities that led to its quick downfall. Silicon Valley Bank ran into problems when start-up financing started to decline and its clients, a mix of technological start-ups and their leaders, began to use their accounts more frequently because the bank's business was heavily focused on the tech sector. The bank has a sizable number of large, uninsured depositors as well; they are the kinds of investors that frequently withdraw cash during times of volatility.
The Next Victim?
Soon after, to reduce risk in the larger financial markets, New York authorities swiftly liquidated Signature Bank on Sunday. Similar to the SVB, over nine tenths of Signature Bank's approximately $88 billion in deposits were uninsured at the end of the previous year. Several of Signature's clients panicked and started phoning the bank last week as Silicon Valley Bank's problems started to spread, fearing that their own money may be at jeopardy. This followed a flood of deposits left Signature's accounts on Friday. The bank's shares, along with the stocks of some of its competitors, also kept falling.
The mitigation mirage
Seeing the plummet of SVB and Signature Bank, bank casualty has become a worrying trend during economic downturns or financial crises when banks face increased pressure and risk. During the rise of inflation, the cost of borrowing money increases as well. Banks that have lent money at fixed interest rates may struggle to collect enough money to cover their costs, resulting in losses. Furthermore, banks that have invested heavily in long-term bonds with fixed interest rates may also suffer losses if interest rates rise, as the value of their bonds decreases.
In addition to the financial impact of inflation and bond investments, there can be a ripple effect on the broader economy. As banks struggle with losses, they may reduce lending or become more risk-averse, which can impact economic growth and business development. Moreover, in a highly competitive banking sector, some banks may take on more risk to maintain profitability, leading to potential problems down the line.
The Biden Government has in fact taken initiative by taking control of the two banks and assured deposit protections. However it does seem that these steps are eerily familiar to the 2008 bank bailouts, but the distinctions that has been made is that this time around the taxpayers won't bear the burden of losses. And in the words of the President, “ Investors in the banks will not be protected. They knowingly took a risk and when the risk didn’t pay off, investors start losing their money.”
That’s Capitalism for you!