Silicon Valley Bank: How interest rates contributed to its collapse and what central banks need to do now

At its peak in 2021, SVB was worth $44 billion and managed more than $200 billion in assets.


Just a week ago it was the 16th largest depository in the United States, and now it has become the second largest bank failure in the country’s history.

A former British Prime Minister, Harold Wilson, is famous for commenting that a week is a long time in politics . But in the world of finance, it seems that everything can change in just two days.

Just 48 hours passed between the US-based Silicon Valley Bank (SVB)’s statement on March 8 that it was trying to raise $2.5 billion (£2 billion) to patch a hole in its balance sheet, and the announcement by the US regulator Federal Deposit Insurance Corporation that the bank had collapsed .

At its peak in 2021, SVB was worth $44 billion and managed more than $200 billion in assets. Just a week ago it was the 16th largest depository in the United States, and now it has become the second largest bank failure in the country’s history. Only the collapse of Washington Mutual during the 2008 global financial crisis was greater.

Although SVB had been in trouble for some time, the speed of its collapse took almost all commentators by surprise, as well as its clients, mostly from the technology sector. Tech companies around the world had their cash locked up in SVB deposits and worried about how they were going to pay their workers and their bills until US government support was announced , along with HSBC’s deal to buy the UK branch of SVB .

And it seems that the panic against SVB that announced its collapse – by some metrics, the fastest in history – is spreading to other institutions with similar characteristics. On March 12, two days after SVB’s bankruptcy, New York regulators shut down Signature Bank, citing systemic risk .

But what happened to the SVB was unpredictable and inevitable? My research suggests not. My latest book on the history of financial crises , Calming the Storms: the Carry Trade, the Banking School and British Financial Crises Since 1825 , happened to be published the day before the SVB went bankrupt and describes three situations in which a banking crisis.

Why the SVB collapsed

One potential cause is when changes in interest rates between countries cause movements in capital flows to start or stop suddenly as investors chase better rates. This affects the availability of financing. This is what happened during the 2007 credit crisis that preceded the global financial crisis, but was not behind the bankruptcy of SVB.

The bankruptcy of SVB is related to the other two situations that I describe in my book.

The first is when interest rates rise rapidly. The cause may be a central bank’s reaction to a spike in inflation , a war , or a tense labor market . In fact, the Federal Reserve, along with other central banks, has raised rates from a band of 0.25%-0.5% to 4.5%-4.75% in the last 12 months.

Higher rates tighten credit conditions. This makes it difficult for financial institutions to finance, while hurting the value of your existing loans and assets.

The second occurs when short-term interest rates rise above long-term rates, as has happened in the United States in recent months. During the pandemic, tech startups with money left over from funding rounds in a world of easy money placed their deposits with the SVB. Given the low demand for loans from this sector, SVB invested most of the money in long-term bonds, mainly mortgage-backed securities and US Treasury bonds.

In short, the SVB took deposited funds mainly short-term and tied them up in long-term investments. So, in recent months, short-term rates have risen more than longer-term bond yields (see chart below). This is because interest rates have skyrocketed, thanks to rate hikes from the Federal Reserve.

Evolution of interest rates in the US

With funding rounds harder to come by in a high interest rate environment, tech companies began to withdraw and spend their deposits. At the same time, these higher rates caused the prices of the bonds in which SVB had been investing to fall. This reduced SVB’s profit margins and put its balance sheet in a delicate situation.

The situation was made worse by SVB having to sell some of its longer-term bonds at a loss to finance the deposits its customers were withdrawing from the bank. News of the sales caused depositors to withdraw more funds, which had to be financed by more sales. A vicious circle ensued.

The March 8 announcement that SVB was trying to raise $2.5 billion to plug the hole in its balance sheet left by these asset sales triggered the bank run that killed it.

Concern about systemic risk

How worried should we be about the bankruptcy of SVB? It is not a major player in the global financial system. It is also unique in modern banking in terms of its dependence on one sector for its customer base and the vulnerability of its balance sheet to interest rate hikes.

But even if SVB’s collapse doesn’t trigger a broader financial crisis, it should serve as an important warning. The rapid rise in interest rates in the past year has weakened the world economy .

The world’s central bankers are walking a narrow path to try to combat inflation without harming financial stability. Central bankers need to manage interest rates more carefully, while regulators should discourage the financial sector from borrowing short to lend long without sufficient coverage of the risks that this entails.

It is also important for central banks to monitor the impact that interest rate differences and cross-border capital flows have on the credit available to both banks and companies. Even if the bankruptcies of SVB and Signature turn out to be nothing more than “small local difficulties” ( to quote another former UK Prime Minister, Harold Macmillan ), the systemic risks that their collapse has revealed can no longer be ignored.The Conversation

Charles Read , Fellow in Economics and History at Corpus Christi College, University of Cambridge