What happened that the Silicon Valley bank had to be bailed out?

What happened to this bank? How is it possible that a creature with 40 years of history, 30 of them without loss, had to be saved?

First of all, we must remember how the bank’s balance sheet works. In the asset, in addition to his buildings and offices, he shows the loans he makes to clients, his investments and his liquidity. In liabilities, in addition to capital and reserves, customer deposits and current accounts.

We must know that when we deposit money into an account or place money for a certain period of time, we are lending money to the bank, and for the subject, this is an obligation, an obligation. In a very simplified but real form (source from the Fed), the balance of the SVB on December 31, 2022 looked like this:

A bit of history

We should be back by 2021. During this year, given the post-coronavirus investment euphoria and cheap money, the bank seized customer deposits and they surged from $102 trillion to $189 trillion, according to the Federal Reserve itself.

This increase in liabilities (think of a bank’s balance sheet) was offset by an asset investment of about half in long-term mortgage bonds, in the expectation that interest rates would not rise as much.

But inflationary pressures have forced the Federal Reserve to implement the most rapid rate hike in 40 years. These increases produced, especially for the SVB, two lethal effects:

1. Depositors compared and preferred to invest in risk-free treasury bills at 4.5% over lower-yield, higher-risk bank deposits, and pulled their deposits out of the SVB at an unprecedented rate.

2. When market interest rates rise, long-term bonds lose value, and they lose more the faster rates rise and the longer the bond is. In this case, for SVB, these rate hikes meant billions of dollars in losses to its portfolio. Unrealized losses (then), but accounted for.

Thus, depositors began to withdraw large sums from their accounts (liabilities). Faced with this outflow of deposits, the bank, unable to claim their money from customers to whom it had lent money on fixed terms, was forced to sell, in order to meet the demand for cash from its customers, the bonds (assets) it bought as investment, but must sell them at a huge loss. These hidden losses are materializing, accelerating, and the bank faces a liquidity shortage.

The Federal Reserve intervened the rescue checking account holders and depositors by insuring all their money (in addition to the $250,000 guaranteed by the FDIC), but shareholders and bank bond holders will not be bailed out.

It should be noted here that when a bank is saved, its deposit and client accounts are saved. Its shareholders, its owners do not save themselves and lose everything, which, on the other hand, is logical. Similarly, those who invested in bonds issued by SVB. Directors have changed, and even now we do not know if the Fed’s quick intervention will solve the problem. But we can already draw some conclusions:

• Obviously, the manager’s mistake was that he financed long-term investments (bonds) with short-term money (deposits).

• Banking business is based on trust. What the bank does with our money is lend it and invest it. When we deposit money in a bank, we lend it to them, and the organization partially lends or invests it. This is your function. I am calm as long as I believe that my money is safe.

• Such rapid and massive rate hikes always have consequences.

• The era of free or almost free money that we have experienced has been a huge distortion of reality and the risk/return binomial.

At the time of this writing, it appears that the Federal Reserve’s intervention has calmed the markets, but the situation is volatile to say the least.

Alvaro Bagnon Irujo, Professor of Financial Management and Investments at the University of Navarra

This article was originally published on The Conversation. Read the original.

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