Rising Interest Rates: The Perfect Storm for The Silicon Valley Bank
Bank failures are complex events that are the result of many underlying factors. When the history of any bank failure is traced, one can see that the trouble is usually present for a long period of time before the culmination takes place and the failure of the banks system becomes public knowledge.
Hence, one can be rest assured that bank failures happen due to a wide variety of factors. If any financial expert or analyst is trying to pin the blame of a bank failure on a single aspect, then they are most likely making an oversimplification. This is the case with Silicon Valley Bank as well.
A wide variety of factors led to the ultimate downfall of this bank. However, the wide variation in interest rates i.e. the Fed going on from historically low interest rates to historically high-interest rates within a short span of time can be considered to be the foremost factor that caused the downfall of the bank.
In this article, we will try to understand how wide fluctuations in the interest rate within a short period of time created a perfect storm which can be considered to be the biggest factor in the demise of the Silicon Valley Bank.
- Lower Interest Rates Led to High Deposits: The first cause of the fall of the Silicon Valley Bank is the fact that it had very high deposits. These high deposits did not occur in isolation. They were also the result of the central banks actions.
During the covid pandemic period, the central banks reduced the interest rates to very low levels. These low-interest rates resulted in excess cash floating around in the system. Also during the pandemic, internet businesses were doing very well. The entire world was locked down.
However, since the internet-based business could be accessed from mobile phones and computers, they were still doing well. As a result, a lot of this money that was floating in the system ended up in the hands of tech-based startups. These startups started depositing large sums of money in their bank accounts which happened to be held and operated by Silicon Valley Bank.
- Higher Interest to Be Paid: As mentioned above, the Silicon Valley Bank saw historic deposits being added to the bank's balance sheet. In a couple of years that the pandemic lasted, the deposits being held by Silicon Valley Bank almost doubled in size. It is for this reason that when the Fed raised the interest rates suddenly, the Silicon Valley Bank found itself in trouble since it had to pay a higher interest rate on more deposits that were present in the system.
- Fewer Loans Issued: When the Fed raised interest rates suddenly and steeply, the startup ecosystem was badly impacted. Many of their costs are linked to interest rates. As such, these costs went up.
Overall, there was a defensive mood in the market. Hence, startups as well as their customers started to shelve their expansion plans. The end result was that Silicon Valley Bank could make fewer loans during this period. Hence, there were fewer loans that were being made at a higher interest rate.
However, there were many deposits that had to be paid at a higher interest rate. This created a cash crunch situation which prompted Silicon Valley Bank to liquidate its assets, which further triggered the crisis.
- More Deposits Withdrawn: A series of sudden and steep interest rate hikes in the economy caused venture capital firms to have a smaller pool of money at their disposal. Since the venture capitalists had less money, they were giving out less money to the start-up firms. Hence, these tech-based startup funds were not receiving more funds to run their day-to-day operations. This meant that they had to rely on the money in their bank accounts to fund these operations.
As a result, tech-based startups were making a lot of withdrawals from their bank accounts. This caused a liquidity crisis at Silicon Valley Bank since the bank had to sell its assets in order to provide the cash which was being requested by depositors. Hence, the high-interest rates caused the number of deposits to quickly fall.
- Fall in Asset Prices: The most significant impact of the rise in interest rates on Silicon Valley Bank was the fact that this rise caused an immediate fall in the price of US treasury bills.
Since US Treasury bills are fixed-income instruments, it is common for the price of these treasury bills to move in an inverse direction as compared to the interest rates. Since the interest rates rose sharply, the price of these bonds also fell sharply. Also, since there was a continuous shortage of cash at the Silicon Valley Bank, these securities had to be liquidated quickly.
Holding these securities till maturity was not an option. This caused Silicon Valley Bank to book almost $2 billion in losses. The news that the bank was being forced to lose money by selling bonds caused the bank run which led to the fall of the Silicon Valley Bank.
The fact of the matter is that a steep rise in interest rates had a multi-pronged effect on the operations of the Silicon Valley Bank. The combination of these various impacts ultimately accelerated the failure of Silicon Valley Bank.
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