A simple overview of the current financial sector and SVB
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This past week has been filled with news on the collapse of Silicon Valley Bank ("SVB").
For three days straight, my LinkedIn feed was filled with people’s take on what happened. The way some analyzed it, you would've thought they saw this coming for months.
In the end, SVB is just one bank in a large, complex banking system. Looking at the situation from a high level can provide clues on what to expect next and precautionary steps to take.
Quick Background on SVB
Silicon Valley Bank's name gives you almost all the details you need to know. They were a bank based in Santa Clara (right outside San Francisco).
Being that it was in the Bay Area, SVB had become the go-to bank for many venture-backed tech startups.
At the time of its collapse, SVB was the 16th-largest bank in the United States and was the largest bank by deposits in Silicon Valley.
How A Bank Collapsed
SVB operates like any other bank, in that it takes deposits from customers and then invests that money to earn a return.
SVB had invested a fair amount of money in long-term Treasury bonds.
[SVB’s bond portfolio] wasyielding it an average 1.79%, far below the current 10-year Treasury yield of around 3.9%.
For years, treasury yields were extremely low, as the Federal Reserve kept interest rates near zero.
But, in the past year, the Fed has raised rates aggressively.
Board of Governors of the Federal Reserve System (US) |FRED
Bond prices move opposite of rates; as rates increase, bond prices fall. This will be important later.
Taking a step back to look at the business environment we are currently in; the Federal Reserve has been raising rates, making debt more expensive. This makes it more costly for business operations, especially ones in Silicon Valley that are tech-based profiles with high debt ratios and low cash flow ratios.
As customers of SVB started to need money for whatever the reason may be in this inflationary, high-interest environment, they withdrew money. SVB doesn't keep all its customer's money sitting in a safe waiting to give it back to people. They invest it.
To cover the deposit withdrawals, SVB needed to sell some of its assets. This includes its bond portfolio.
To fund the redemptions, Silicon Valley Bank sold on Wednesday a$21 billion bond portfolioconsisting mostly of U.S. Treasuries. This forced SVB to recognize a $1.8 billion loss
As mentioned earlier, higher rates mean the bond prices are lower, so SVB took a loss on the investment.
Any situation like this is a lose—lose for a bank; it loses customers' deposits and is forced to sell assets earlier than desired, usually at a loss.
If enough people withdraw money from one bank, it garners attention. Other customers do it as well, in fear of losing their money. This starts a cycle known as a bank run which causes a collapse.
Evaluating the Rest of the Financial Sector
Where there's trouble, more follows. There is always a fear that when one bank collapses, more will follow since they are all connected.
Since SVB's collapse a week ago, Credit Suisse needed a lifeline from the Swiss National Bank (for $53 billion) and First Republic Bank received $30 billion in depositsfrom other financial institutions.
The scary thing is, this is exactly what the Fed wanted to happen. Maybe not directly so, but these are the consequence needed to achieve their desire tostop inflation.
The Fed wants less liquidity.
I believe that other banks, especially larger ones, are not worried; they are likely in good spots.
And as we saw in 2008, and now, banks will most likely get rescued in some way.
The question is if this situation does become really bad (which I don't expect it to) will the Federal Reserve step in? They have made declarative statements saying they will raise rates and keep them elevated; that their number one goal is taming inflation. But taking a look at theirbalance sheetand what they did last week might tell a different message…
How to Protect Yourself
There are a few lessons that individuals can learn from this experience.
The first is that you should diversify your money. The FDIC insures your deposit at a bank up to $250,000. So if you have all of your money in one bank and it's more than $250k, it's probably worth moving some of that to a different institution.
The second lesson is that liquidity is crucial. Lenders always want to know how much liquidity is available in case money stops coming in.
If you lost your main source of income tomorrow, would you be able to cover your expenses? And for how long? How fast can you get cash — by legal means — if you are running low?
We are entering choppy times. I would have previously said "we are entering a high-interest environment", but the Fed may be easing on its mission of quantitative tightening. I'd like to believe they are much smarter than me; so if they are taking their foot off the gas there may be trouble on the horizon.
Only time will tell.
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