SVB & Signature Banking Meltdown causes and future implications

 

The later weeks have been characterized by a series of bank runs and contagions that have led to two of the largest banking collapses in US history. Silicon Valley Bank also known as SVB was the 16^th largest bank in the United States at the time of its bankruptcy, representing the second largest bank to remain insolvent ever in US history, while Signature bank, although much smaller in size than SVB represented the 3^rd largest failed bank. This recent banking collapse could, to an extent, be comparable to that of 2008 considering that the second and third largest baking collapses have occurred within a matter of weeks. Although relatively small banks have failed so far, current, and future economic implications could make the recent crisis worse than many expect, especially if governmental entities do not embark on taking the right policies to safeguard investors, depositors, as well as mitigating risk through properly regulating banking policies. This paper will go over the causes of each bank’s collapse, current & future implications, as well as my probable solutions to prevent such events from happening again.

               Although business had recently been booming for Silicon Valley Bank, overleveraging of business activities and a failure to plan accordingly is what has led the bank to become insolvent. Founded in 1983, SVB had always focused its business upon a high-risk, high-reward approach, becoming a key player in the startups and tech ventures financing sector throughout the years. Many startups were keen to partner with the bank for business loans although this activity came with considerable business risk for the bank as loaning money to promising ventures is not always a safe bet. Nonetheless, business risk was a relatively smaller reason leading to the bank’s failure. Since the quantitative easing period following the Covid-19 crisis, deposits at SVB tripled within a matter of a few years as the government was incentivizing new ventures through relief checks and more upcoming businesses were deciding to partner with SVB for funding. The recent influx of deposits motivated SVB’s management to make the decision of buying around $100 billion in long-term government securities, move that proved fatal. At the time, the Federal Reserve was hiking rates a pace that had not been seen since the 80’s, so the long-term bonds SVB was in possession of were posting unrealized losses of around $17 billion. Once the bank had to report this number in their financial statements, investors started rushing to withdraw their funds from the bank fearing a liquidity crisis. This brought to a banking run whereby SVB did not have enough funds to cover all the deposits, leading to the bank’s failure.

               Many attribute Signature’s failure to its business activities that related not only to the Cryptocurrency markets, but also a portfolio of tech startups. With the recent devaluation in cryptocurrency prices during the year of 2021 as well as the fallout following SVB’s collapse, followed a bank run on Signature Bank as investors started fearing the extent to which the two banks were interrelated.  

               Although the two banks collapsing swept fear among the markets, the US government decided to step in and bail all depositors out regardless of deposit amount. In other words, most regulated banks in the US are covered by FDIC insurance that makes whole depositors for a deposit amount of up to $250’000 in case of a bank’s insolvency. This policy was set in place after the great depression ended in 1933 to restore trust in the banking system. Although the FDIC’s insurance caps the amount to $250’000, in this instance, the US government decided to bail out even deposits that exceeded that amount to calm depositors and investors and make sure that the banking contagion would not propagate to other regional banks. So, in the end, no funds were lost because of the banks’ collapse.

               Nonetheless, a short-term risk of a bank contagion persists as Janet Yellen assured that saving all depositors from the two banks was going to be a one-time-exception that would not repeat, meaning that possible following banking collapses will not probably be fixed by bailouts. Such a statement increased the risk many depositors in regional banks perceive to keep their money at smaller institutions and they start preferring to keep their funds at banks that are perceived to be more “too big to fail.” In other words, following the collapse, depositors at smaller banks are more on the look out as to how their banks operate and a slight sign of fear might see the market see a flight of capital from smaller banks to larger ones, leading to a bank contagion among smaller institutions.

               The Federal Reserve’s inflation policies were also revised as a result of the recent bank runs. In fact, one of the contributing factors to the meltdown was the speed of recent FED rate hikes to combat a surge in inflation. It showed how excessive hikes could lead many overleveraged parties in the economy to eventually “break,” meaning that it was the time for the FED to revise its interest rate policies. For example, before the SVB collapse, the Federal Reserve presented a nearly 50% chance that it would increase its rates by 50 basis points at its next meeting, while after the bank collapse, a 50-point hike became completely off-the-table as the markets started favoring either a 25 basis point or no hike at all. However, slowing down hikes at a period when inflation still is cooling down and nowhere near the target of 2% inflation imposed by the FED poses a great risk that an insufficient rate hike might lead to another surge in inflation, while an excessive hike could pose exaggerated risks of recession as an increasing number of companies and banks fail because of excessive federal funds rate levels.

               As the saying goes, “it is better to prevent a problem rather than trying to cure it later on” because current market conditions are presenting a great dilemma that could have, to a certain extent, be prevented if the Federal Reserve had decided to print less money following the Covid-19 crisis. If it had done so, many less institutions would be overleveraged, while the dilemma of rate hikes and recession would pose less of a risk. However, the past is past, and the US government should think in the present. Some solutions to the recent meltdown would be to increase regulations on small banks by reversing some of the Dodd-Frank regulations that President Donald Trump had rolled back in 2018 regarding small-banking activities, while also move smaller banks towards a safer environment through increased regulations and higher reserve requirements. This could mitigate the business risks that many small banks pose to the economic system while sustaining substantial withdrawals from depositors who move their funds from regional banks to larger ones. One last solution to preventing any further issues from arising would be to lead a more sustainable approach to rate hikes to prevent a recession by getting inflation down to target at a slower pace that does not endanger other parties more than is needed.