Financial journalists have been scrambling over the last four days to explain the swift collapse of Silicon Valley Bank (SVB) late on Friday afternoon. Whilst much will be written, here is our attempt, albeit simplistic, to summarise in 300 words. Traditionally, banks generate profit by lending long at higher rates (think mortgages) and borrow at shorter, lower rates (think current accounts). The spread, or difference between the two, is the main driver of ‘net interest income’ (NII). Generally, banks have enjoyed greater NII as rates have risen. Herein lies the rub for SVB.
Given the name it’s no surprise that many of SVB’s main clients are in the tech/venture capital space. These companies became incredibly cash rich during the pandemic and flooded SVB with deposits. Which is all fine, but SVB struggled to lend this money out long term (mortgages, longer dated business loans) and therefore couldn’t maximise their NII. The most obvious option is to invest this excess capital in government bonds. Most banks (particularly those subject to Basel III rules) stick to the shorter end of the curve – this reduces the return but attempts to minimise the maturity mismatch between the assets (the bonds) and the liabilities (the current accounts).
However, SVB pushed their investments further out the yield curve to chase return. As we all now know (as seen in bond returns in 2022) these longer dated bonds are hit harder in rising interest rate environments. All fine, if you don’t have to (a) mark to market your bonds (b) liquidate the investment and can simply hold to maturity.
Now, remember the deposit base? Those firms struggled in 2022 and had to run down their own deposits, prompting withdrawals from SVB. After a while, this forces the bank to liquidate those bond investments to pay out the deposits, thus crystalising the paper loss. The economic backdrop worsens, rumours begin to fly, and the ‘doom loop’ gathers pace until ultimately there isn’t sufficient assets (bonds and lending) to cover the liability liquidity calls (current and deposit accounts). And all that, is how we can still experience a classic bank run in 2023.
As always, if you wish to discuss anything in further detail, please do get in touch.