Last week, my investment portfolio, which consists of 27% equities in the finance sector, experienced a tumultuous ride after the collapse of Silicon Valley Bank (SVB), the 16th largest bank based on its 2022 annual report, followed by Signature Bank. This event raises concerns about a potential financial crisis similar to the one in 2008.
The collapse of SVB would be predictable if investors examined their previous financial statements. The expansionary fiscal and monetary policies in 2020 and 2021 provided unprecedented liquidity to the market, leading investors to shift towards risky investments like start-up companies. SVB, whose clientele is mainly venture-backed companies, benefited from a large increase in deposits, as their deposits tripled from 2020 to 2021. SVB intended to achieve higher investment returns with this large increase in deposits, so they invested around two-thirds of the deposits in long-term fixed-income securities.
However, the duration (interest-rate risk) of long-term securities is higher than short-term securities, and the duration will increase as the interest rate increases. The Federal Reserve’s interest rate hike caused SVB’s duration to increase by 50% from 4.1 years in 2021 to 6.2 years in 2022, resulting in a $15B loss in 2022 (cumulative profit of SVB over 30 years is around $10B). The withdrawal request of $42B, approximately a quarter of the total deposit, ultimately led to the collapse of SVB.
The fear of a disastrous financial crisis originated from the severity of the loss this year, which was more problematic than in 2008. Although there were 140 bank failures in 2009 and 154 in 2010, the assets owned by failed banks totaled $170.9B in 2009 and $96.5B in 2010 according to Federal Deposit Insurance Corporation (FDIC). However, SVB owned $209B worth of assets, which was more than what all failed banks owned in 2009; while Signature Bank owned $110.4B, which was more than what all failed banks owned in 2010.
Moreover, I believe a more influential factor is the panic sensation created by the media. Since the collapse of SVB, all major news outlets have been covering this event and some started to project an imminent financial crisis. If the panic started to spread across the country, especially among people who deposited in small-and-medium-sized banks, it would become a trust crisis among depositors. Consequently, more bank runs will occur to such an extent that even banks with robust solvency would be jeopardized.
However, it is important to note that the current market conditions are fundamentally different than in 2008. The overheated economy and inflated housing market contributed to the previous financial crisis, while the poor risk management of certain banks amidst the “overcooling” of the economy caused the current bank collapses.
On the other hand, investment banks took the blame of the previous crisis because of their use of excessive leverage and innovative but risky financial derivatives. Investment banks also conducted businesses with other financial institutions such as hedge funds, insurance companies, and asset management firms. During the current event, only commercial banks and their depositors are affected, which is unlikely to have detrimental effects on the entire financial system. Moreover, a large proportion of commercial banks are insured by either FDIC, an independent agency that can guarantee payment to depositors, or other insurance agencies which further mitigates the risk of a major financial crisis.
The downfall of Silicon Valley Bank serves as a poignant example of the significant repercussions that can result from avarice and speculation. Despite being ranked “America’s BestBank” by Forbes, the company’s insatiable desire for greater financial returns led to the assumption of additional risks. Unfortunately, these risks proved to be excessively hazardous, ultimately resulting in significant losses and the collapse of the once-robust financial institution.
In light of this event, it is prudent to ensure that your bank is insured by FDIC or other agencies, and to verify the extent to which your deposit is protected to safeguard your financial health. In my opinion, while there is still potential for a significant financial crisis to occur, the likelihood of it happening is highly unlikely. Though the recovery from this incident will depend on the fiscal and monetary policies, as individuals become more composed, the financial market is anticipated to undergo a self-adjustment over time.