The collapse of Silicon Valley Bank and shutdown of Signature Bank of New York have sparked global
fears of a widespread financial meltdown. Both banks catered to the tech industry. Silicon Valley was important to venture capital firms while Signature was a key financial institution to the cryptocurrency industry.
While Silicon Valley Bank is relatively unknown outside of California, it’s an important bank for venture capitalists. In fact, roughly half of U.S. venture capital-backed technology and healthcare companies are financed by Silicon Valley Bank. Some of its clients have included Airbnb, Cisco, Fitbit, and Pinterest.
What Happened to Silicon Valley Bank?
The collapse of Silicon Valley Bank is the second-largest failure of a federally insured bank in U.S. history. The regional financial institution held over $200 billion in assets. What brought down the 16th largest bank in the U.S?
When interest rates were forced to zero, Silicon Valley Bank invested in long-date U.S. government bonds—bonds have an inverse relationship with interest rates. When rates rise, bond prices fall. When the Federal Reserve began to aggressively increase its interest rates to get a handle on decades-high inflation, Silicon Valley’s bond portfolio started to lose value.
If Silicon Valley Bank was able to hold onto those bonds until they matured, it would have received all of its initial capital. But rising interest rates and high inflation have been economic headwinds for the tech industry. As a result, cash-strapped tech stocks began to withdraw their deposits.
Silicon Valley Bank didn’t have enough money to cover the withdrawal so it had to generate capital to shore up its balance sheet. On March 8, it said it was selling $2.25 billion in stock to raise funds.
It needed funds to fill a $1.8 billion gap caused by the loss of a $21 billion sale of bonds. The portfolio was yielding 1.79%, well below the current 10-year Treasury yield of 3.9%.
Fearing the bank didn’t have enough cash on hand created panic with customers rushing to protect their wealth.
Despite assurances from President Biden that deposits at Silicon Valley will be covered and the U.S. banking system is safe, investors weren’t feeling as confident. Fear gripped Wall Street and within days, Silicon Valley stock had cratered 60%. Within 24 hours of announcing a $2.25 billion share sale, Silicon Valley bank had collapsed.
This has many questioning whether Silicon Valley Bank’s exposure to rapidly rising interest rates is quietly impacting other banks that are over-exposed to falling bond prices.
How Will This Affect Interest Rates?
Central banks have been hiking their interest rates over the last year to tackle stubbornly high inflation. The Federal Reserve has raised interest rates from a range of zero to 4.5% while the Bank of Canada has raised its interest rates from 0.25% to 4.25%.
The Bank of Canada said it will pause future interest rate increases while the Federal Reserve has said more hikes are needed to get a handle on inflation. But the collapse of Silicon Valley Bank and Signature and now concerns about corporate balance sheets caused by rising interest rates has put that in jeopardy.
There is a growing consensus that the Bank of Canada could announce a 0.25% cut when it meets next in April. The markets also believe the central bank could announce a 0.5% interest rate cut this summer.
The Federal Reserve was expected to announce a 0.25% rate hike when it meets on March 22, boosting interest rates to a range of 4.5% to 4.75%—the highest range since October 2007. But now, analysts think the U.S. central will have to eventually cut interest rates.
Beyond systemic issues in the global banking industry, there are other issues which could create economic risks over the coming quarters and years, including the 2024 U.S. election cycle, rising geopolitical tensions with China and Russia, and ongoing issues with COVID-19 and potential Black Swan events.
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