by Aristotle Bournazos

There was a lot of uneasiness in the financial world these last two weeks.  That is because Silicon Valley Bank (SVB) collapsed. . . . . . .but what really happened?

 First, we have to understand the basics of what banks do.  Banks take customer money held in bank accounts, called deposits, and invest that money in the hopes of making a profit. From this profit, the bank will pay the customer a small amount of interest on the money the invested from these accounts and keep the rest for themselves.  The Bank will need to have a certain amount of money available in the bank to give to its customers if they want to withdraw money out of their accounts.  The Banks don’t know how much money their customers may withdraw on any given day but based on history and statistics they usually have the expertise to estimate and manage withdrawals.

 What is SVB

 Silicon Valley Bank (SVB) was a bank that focused on helping new start up companies who were not making money yet.  These companies relied on investments from outsiders and borrowing to pay their bills and pay their employees.

  The Downfall SVB

With interest rates rising very quickly these businesses were having trouble borrowing money and raising money from investors .  As a result, they started to use money they had deposited in their SVB accounts to pay their bills and pay their employees.  The bank did not anticipate how many depositors would start withdrawing money from the bank and did not have enough money on hand to match withdrawals. To raise money to match withdrawals the bank started selling some of the investments they made using the customers deposits.  Unfortunately, the bank did not invest this money very well and sold these investments at a loss.  This is because the bank did not manage its investments well.  It was not that they invested in risky investments, they did not.  They invested in long term US government bonds which are a very safe investment.  The problem was that more than half of their customers deposits were invested in long term US bonds which would not mature for a long period of time.  High interest rates and customers withdrawing money forced the bank to sell these long-term bonds prematurely which in turn caused them to lose money on the sale of these investments. But even after selling these investments they still did not have enough money to meet withdrawals. So, to raise additional money to meet these withdrawals, the bank decided to sell stock to raise money.  When this happened, many customers took this as a signal that the bank was financially unstable and would go out of business.  More customers decided to transfer all their money out of the bank.  This is called a run on the bank.  As a result of this run on the bank government regulators had to close the bank on March 10, 2023, because the bank could not meet the customer withdrawals. 

Then What?

The Federal Government was afraid that the situation at SVB could also be a problem at other banks as well.  Signature Bank was shut down by the government two days after SVB was shut down.  This was done because Signature Bank was heavily exposed to volatile Crypto investments and the government didn’t want a run on that bank too. To try to calm any fears that the banking industry in general was not stable, the Government guaranteed that whoever had money deposited in SVB and Signature Bank would not lose any money.  In addition, they promised other banks that they would make money available to them if they needed to meet withdrawals.  This was done to make sure the whole banking system didn’t collapse and there wasn’t a run on all banks.

The Future

Due to the rapid rise of interest rates many investments are worth far less than what some banks had predicted.  This could still lead to other banks suffering the same fate as SVB and Signature Bank.  Banks are now holding on to money and not lending money to businesses who need money to grow, pay bills and pay employees. How this will affect the overall economy is unknown. Only time will tell.