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The mismanagement of risk that led to the collapse of SVB

The banking sector has once again been in the spotlight for the worst reasons in recent days. After the bankruptcy of the prestigious cryptocurrency bank Silvergate, the impact on the banking sector seems to extend to the rest of the banks with exposure to the technology sector.

The most recent case is that of Silicon Valley Bank (SVB). The bank’s financial conditions have been deteriorating in recent years, but it only took two days for the bank to completely collapse. SVB had issued a statement announcing the need to raise around 2.5 billion dollars to plug a hole in its accounts, which ended up causing panic among investors. Factors like:

  • Race to the elevators.
  • Exposure to a volatile industry, such as technology.
  • Impact of rising interest rates on bond prices.
  • Lack of liquidity.

They contributed, of course, to the bank’s downfall.

Concerns about SVB’s financial health increased, triggering a run on deposits by clients. The bank ended up not resisting the massive withdrawals of funds by its clients, especially technology companies and Opening.

The current economic climate, where interest rates have been rising sharply in recent months, also contributed to the bank’s downfall, as it held large amounts of capital in long-term treasury bonds, penalized by rising yields.

To give you an idea of ​​the size of the institution, this was the 16th largest bank in the US, with assets of $209 billion at the end of 2022 and around $175.4 billion in deposits.

Are we facing a systemic or idiosyncratic risk?

So far, there is no concrete data that the bank’s bankruptcy could have a contagion effect on other banks. Recently, the US Federal Reserve and US Treasury Secretary Janet Yellen decided to shut down Signature Bank operations to stop a possible contagion.

However, it is important to note that there are several banks with similar business models to SVB that may also be exposed to the current circumstances and that reacted quickly to the bankruptcy announcement, such as First Republic Bank or Western Alliance.

Interestingly, there are institutions in much more vulnerable financial situations than the recently failed Silicon Valley Bank (SVB). Source: Bloomberg

root of the problem

Now, going back a bit in time, from 2017 to 2022 SVB recorded exponential growth: the bank’s deposits more than quadrupled, from €44 billion to €189 billion. In recent years, the bank has opted for a risk management strategy that involved investing in Treasury and mortgage bonds, which represented more than 50% of the entity’s assets.

However, the bank in recent years has begun to collect some red flags, and the current economic situation ended up exposing these weaknesses even more. Most of the bank’s clients were businesses, particularly Opening technology, the latter being more exposed to potential risks through the increase in interest rates, which had a direct and negative impact on company valuations, causing the entry of VCs (“Venture Capital”, in Portuguese, venture capital) will decline and, in some cases, walk away. This ended up generating liquidity problems for the companies which, in turn, had to resort to the deposits they had with the SVB.

Coupled with Silicon Valley Bank’s (bad) risk management strategy and the run on deposits, the bank ended up not holding up. It is not common for a bank to have such a large exposure (more than 50%) of its assets dedicated solely to Treasury bonds (which became vulnerable with interest rate hikes), and when the bank needed to liquidate part of these investments to gain liquidity it ended up incurring huge losses that led to the bankruptcy of the bank.

And in Europe?

In Europe, the banking sector could not remain indifferent, as all the major European banks ended up posting violent declines (see table below). In addition, concerns about the financial situation of Credit Suisse increased again after the Credit Default Swaps (CDS) hit all-time highs.

However, recent events could serve as a starting point for central banks to start thinking about the impact of rising interest rates, particularly in Europe as well, as the ECB should continue to raise interest rates steadily. more aggressive than other central banks, since interest rates also started to rise later.

On the other hand, we continue to face a scenario in which inflation remains high and far from being under control, so stopping interest rate increases could jeopardize the fight against inflation. Undoubtedly, this will not be an easy decision for those responsible for monetary policy to make.

Reaction of European banks to the latest news of 03/13/2023. Source: Bloomberg

Source: Observadora

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