What Happened to Silicon Valley Bank?
If you are not paying attention to the Silicon Valley Bank collapse, you should be. This applies even if you are not a technologist or financial fanatic like myself. This post is intended to walk through how this collapse could have rippling effects across every business sector and how people might mitigate damage and capitalize on opportunities.
In case you haven’t heard, a very large bank, called Silicon Valley Bank, collapsed on the 10th of March 2023, two days ago as of this writing. There were a number of factors leading up to this but the nail in the coffin was a run on the bank. If you would prefer to watch this in a video series, check out this playlist.
What is FDIC?
Before we get into walking through scenarios for how this can impact every facet of our society, we need to learn some background, starting with what FDIC is.FDIC stands for Federal Deposit Insurance Corporation.
In response to the Great Depression, the FDIC was created to restore faith in the US banking system. It is intended to prevent situations like a run on the bank because people need to feel secure that they can access their money, if needed.
What this means in practice is that the FDIC will guarantee that $250,000 of each depositors funds will be available within days of a bank becoming insolvent. That is a fantastic thing for your average banking customer since they do not generally keep that amount of money in a normal bank account.
The FDIC has taken over Silicon Valley Bank and will be granting access to all insured funds within days. The problem in this scenario is that insured deposits at Silicon Valley Bank only made up a small portion of the customer deposits. It is hard to find an exact number right now, but it appears to be somewhere above 85% to as much as the high 90s percent of funds are not FDIC insured.
This leads to the next term that we need to know in order to understand the magnitude of this situation. That is fractional reserve banking.
What is Fractional Reserve Banking?
Our system operates on what is called fractional reserve banking, which means that banks need only maintain a small fraction of the customer deposits on hand. That percentage is usually 10%, but in response to the pandemic, this was reduced to 0% and that policy still remains in place. This basically means that when you deposit funds in your checking account, the banks could potentially loan out 100% of your deposit.
You might see how this could become a problem, if people lose faith that a particular bank can honor deposits, especially if many of the customers are above the FDIC limits, which leads to the next concept we need to understand.
Bank Run aka Run on the Bank
A bank run or a run on the bank is a situation in which depositors worry that a bank is at risk of becoming insolvent. Insolvency in financial terms means running out of money to pay debts or to fulfill withdrawal requests. When many people start to think that a bank is at risk of insolvency, they will attempt to withdraw or transfer all of their funds away from that bank.
In the case of SVB, one of the big players to start the bank run was Peter Thiel. He is probably most commonly be known as one of the co-founders of PayPal and one of the first investors in FaceBook. He is now primarily a venture capitalist, which basically means startup investor. A few days before the collapse, he and many other VC firms started telling their portfolio companies to move money out of Silicon Valley Bank.
These types of accounts would have been highly exposed since they are well above the FDIC protection limit. This would be large amounts of money, millions if not billions of dollars trying to move out of SVB all at once.
What Banks Do With Our Deposits
Some portion of bank deposits are kept in cash reserves, which would either be in physical cash in vaults or deposits with a central bank, which is the Federal Reserve in the case of the United States. Even if the current reserve requirements are set to zero, any given bank should and will keep reserves for normal operations to facilitate transfers and withdrawals for customers.
The rest of the funds will be invested in generally safe vehicles with relatively low yields. Two of the big items that fall into that bucket are Treasury Bonds and mortgage backed securities. That is where SVB and possibly other banks are very exposed.
When interest rates are going up, the value will go down for mortgage backed securities and bonds that are at lower rates. SVB had holdings with very long terms that were locked in between 1 and 2 percent, whereas current yields are around 5%. In order to meet transfer and withdrawal requests this week, SVB had to liquidate positions at huge losses. This caused ripple effects and panic, causing more transfers and withdrawals, eventually leading to lines outside of branches, and finally the FDIC taking control of the bank.
You might be asking, why does this matter to me if I have no funds there? Well, next up, we will discuss how this is already impacting normal people with no banking at SVB.
