Why SVB And Signature Bank Failed So Fast?

Silicon Valley Bank and Signature Bank failed with enormous speed - so quickly that they could be textbook cases of classic bank runs, in which too many depositors withdraw their funds from a bank at the same time, according to a PTI report.

Stock markets plunged, with banking stcoks across the globe feeling the heat. In India too, its implications felt with select banking stocks being hammered. The only silver lining from such an event has been that the fact that the US Federal Reserve Bank of India may reconsider a move to hike interest rates by another 25 basis points.

Hiking interest rates too fast and too soon, may also have had some part to play in the collapse of these banks. As we write stock markets have recovered hoping that the US Fed would go slow on the interest rate cuts part of it. Fed officials are now slated to meet on March 21 and March 22 and there could be a pause in interest rate hikes following the Collapse of Silicon Valley Bank and Siganture Bank.

What led to the collpase really?

The Federal Reserve has been aggressively raising rates - 4.5 percentage points so far - in a bid to tame soaring inflation. As a result, the yield on debt has jumped at a commensurate rate.

The yield on one-year U.S. government Treasury notes hit a 17-year high of 5.25% in March 2023, up from less than 0.5% at the beginning of 2022. Yields on 30-year Treasurys have climbed almost 2 percentage points.

As yields on a security go up, its price goes down. And so such a rapid rise in rates in so short a time caused the market value of previously issued debt - whether corporate bonds or government Treasury bills - to plunge, especially for longer-dated debt.As yields on a security go up, its price goes down. And so such a rapid rise in rates in so short a time caused the market value of previously issued debt - whether corporate bonds or government Treasury bills - to plunge, especially for longer-dated debt.

For example, a 2 percentage point gain in a 30-year bond's yield can cause its market value to plunge by around 32%.

SVB, as Silicon Valley Bank is known, had a massive share of its assets - 55% - invested in fixed-income securities, such as U.S. government bonds.

Of course, interest rate risk leading to a drop in market value of a security is not a huge problem as long as the owner can hold onto it until maturity, at which point it can collect its original face value without realizing any loss. The unrealized loss stays hidden on the bank's balance sheet and disappears over time, PTI report stated.Customers of SVB were withdrawing their deposits beyond what it could pay using its cash reserves, and so to help meet its obligations the bank decided to sell $21 billion of its securities portfolio at a loss of $1.8 billion. The drain on equity capital led the lender to try to raise over $2 billion in new capital. The call to raise equity sent shockwaves to SVB's customers, who were losing confidence in the bank and rushed to withdraw cash. A bank run like this can cause even a healthy bank to go bankrupt in a matter days, especially now in the digital age.

With inputs from pti