The banking industry revolves around the trust hoax, and no bank can survive if enough depositors want to withdraw their money at the same time, history is full of bank bankruptcies, so banks should avoid any reason that may call customers to withdraw their deposits at all, which Silicon Valley Bank (SVB) failed to avoid despite being ranked 16th in the list of the largest lenders in the United States.

Most of Silicon Valley Bank's customers are companies with deposits of more than $250,<> protected by the Federal Deposit Insurance Corporation (FDIC), and the bankruptcy of this bank means these companies also incur losses, and Silicon Valley Bank has used these deposits to buy long-term bonds at the peak market.

Although it was assumed that the collapse of the bank would not provoke contagion in the sector, withdrawal requests from other regional banks in the following days showed widespread contagion, in which case, the situation required the intervention of the authorities.

Before markets reopened on March 13, the Federal Reserve and the Treasury revealed that Signature, New York's lending bank, had also gone bankrupt, followed by two measures to protect against further collapses:

  • Consolidation of all Silicon Valley Bank depositors and Signature with one entity.
  • The Federal Reserve establishes a new emergency lending institution called the Bank Term Financing Program.

The measure will allow banks to deposit high-quality assets against a cash advance equal to the asset's face value, rather than its market value, protecting banks that hold bonds that have fallen in value from facing the same fate as Silicon Valley Bank.

These events raise profound questions about the U.S. banking system: post-financial crisis regulations were supposed to mobilize banks with capital, increase their cash reserves, and reduce the risks they were able to withstand.

The Federal Reserve and the Treasury Department have made the expected interventions in any crisis and essentially reshaped the financial structure, but at first glance the problem seemed to lie in poor risk management in one bank.


Impact of interest rates

To assess the probabilities, it's important to understand how changes in interest rates affect banking institutions.

When interest rates were approaching zero at the beginning of 2022, U.S. banks had $24 trillion in assets and about $3.4 trillion of them were in cash on hand to repay depositors, about $6 trillion in securities mostly Treasuries or mortgage-backed bonds, and another $11.2 trillion in loans.

U.S. banks have financed these assets with a massive $19 trillion deposit base, about half of which was insured by the Federal Deposit Insurance Corporation. In order to protect their assets from losses, banks held two trillion dollars in high-quality "first-class assets."

But after the rise in interest rates to 4.5%, the collapse of Silicon Valley Bank drew attention to the fact that the value of bank portfolios fell as a result of this rise without mentioning this predicament in the balance sheets, while the Federal Deposit Insurance Corporation reported that US financial institutions have $ 620 billion in unrealized losses in the market.

Fragile banking system

Sometimes deposits can vanish overnight like Silicon Valley Bank in a way that led to its collapse, and banks with large, low-cost deposits don't need to worry about the market value of their assets, but banks with high-value deposits worry a lot.

High interest rates have led to mismatches between assets (what banks have) and discounts (what they owe to third parties) causing Silicon Valley Bank to collapse, and high rates have revealed problems with bond portfolios, as markets show in real time how the value of these assets falls when interest rates rise, but bonds are not the only assets that carry risk when fiscal policy changes.

This has resulted in a more fragile banking system that has been thought by regulators and investors, as it is clear that smaller banks with unsecured deposits will soon need to raise capital.

Since one-third of the assets in the U.S. banking system are owned by smaller banks than Silicon Valley Bank, these banks will now tighten lending in a bid to strengthen their balance sheets.

The bankruptcy of Silicon Valley Bank has also upended other models of post-crisis financing.