Why SVB Failed? How about other banks?

How / Why banks are failing?

I am sure you have seen plenty of news and analysis around, let me write it down clearly for you:

First, let’s understand the Banks basic business model: 

The bank usually take money from *A* and lend it to *B*

*A* are depositors who get interest slightly lower than Central-Bank interest rate, *B* are the borrowers who pay higher interest. usually slightly higher than CB interest, 

the bank profit is the difference between these two rates. 

The bank keeps making money as long as it lends out up to 90% of the deposited money, which means they don’t hold your deposited money, they have to lend it to others or invest it somewhere with low risk (let’s call this *X* ), otherwise they lose money if they just had to keep depositors money and kept paying them interest.

Now let’s think, where banks can fail?   

based on the banks business model, generally the bank may fail basically if:

1) large number of depositors *A* asked their money at the same time  , aka bank-run because banks don’t hold more than 10%~20% of the money.  

2) if large number of borrowers (*B*) stopped being able to pay-back their debt, Example: 2008 housing market crisis where large number of borrowers couldn’t pay their mortgages.

3) if the bank couldn’t find enough borrowers (*B*) so in this case it has to pay the lenders while not making profit. 

4) if the bank got a massive loss in its investment (*X*) ,  to avoid this, banks are usually investing most of *X* in Bonds/treasury bills, lending this money to US government and taking fixed interest for 5, 10, 20 or 30 years

the issue with these governments issued treasury bills, is it gives FIXED interest for specific number of years,  for example they were giving 1% for their 10 years bills issues in 2019

now since  the interest rate is near 5%, new bonds/treasury bills are much more attractive because they pay out way higher interest, accordingly what happens is, the other (pre-2022) treasury bills / bonds with low interest rate are being sold with discount, cheaper than their value

But don’t worry, this is not the first time in history that interest rates go up and this bills value decline will be unrealized loss if you don’t sell them,  it’s only a real loss if you sell them. but if you hold till their expiry date then the US government or whoever issued them will pay their named original issued value.

What happened with SVB?

First, it’s good to know that SVB is mainly the bank which handles +50% of all startups in US, most are in Tec. Sector.

 Startups made huge overvalued IPOs and fund raisings in 2017-2021 era where cheap money was everywhere and investors were ready to throw their money anywhere. 

These startups hold most of this money in SVB and they withdraw money when they need to fund their operations.

While 2008 crisis was basically caused by *B* (the borrowers), SVB had a new sort of problems, it had a combination of issues related to  A & C and rating agencies interruption:

*A* went down: (less and less depositors as 2022 was down-only year and almost no IPOs or fund raisings were happening)

these Startups kept slowly withdrawing their money to fund their operations during 2022 as they couldn’t raise new money in such tough year. SVB cash was getting drained.

*C* went down:  as the bank needed money to keep paying out interest to A holdings and cash to A withdrawals, it needed cash, so it had to sell some of its investments which were mainly Treasury bills, so they sold at LOSS, the unrealized loss became realized loss.  and the surprise is, 57% of SVB investments were in these treasury bills while other banks are usually investing only 20-40% in it

Here comes Moody’s who understood the underlying risk of SVB overexposure to low interest rate treasury bills and to its cash flow problems, and how it had to sell some of these , so Moody’s called the bank and informed them, dudes we gonna have to downgrade your bank rating by two degrees in one shot, which would lead to panic and bank run if Moody’s did so, here the Bank said PLEASE don’t do, we will fix it, and they decided to sell part of the bank as a fund raise through new Stocks issuing + part of the treasury bills they have to get some liquidity and fix their broken balance sheet, all this was happening few days before the collapse and NO ONE knew anything except Moody’s & SVB CXOs.

Moody’s said ok, we will give u few days to fix this.

8th of March, the bank sold 21 billion dollars of its *X* (treasury bills) at a realized loss of 1.8 Billion dollars, in parallel issued new stocks through Goldman Sachs, here the 2nd disaster happened, 70% of the offered stocks couldn’t be sold because the problem details was leaked and the sock price started its free falling (who leaked this?) 

This was followed by a typical bank-run as everyone is aware of the liquidity issue in SVB now.

24 hours later all cash was withdrawn and the real time balance in the bank was -958 million dollars, typical bank-run , it’s all gone. and the bank fully collapsed and closed.

in parallel, chain action was about to happen in other US banks, another bank called Signature bank collapsed the very next day , here we came to the famous 11-12 March weekend, which was a weekend but US official agencies from SEC to FED to FDIC to US president decided to step in & take immediate actions to avoid another 2008.

the US government pledged to pay all depositors, even those with +250k$ holdings which are usually not protected by the FDIC insurance law, but they gonna be paid this time because the US gov. decided to making sure not to give any chance for 2008 crisis to be repeated here.  so far we can say they saved the markets, but let’s see because as long as they run the markets with high interest rates, the problems will keep popping up, this time SVB, next time we expect a big borrower to fail leading to another chain effect for its lenders.

in parallel, UK-SVB , its arm United kingdom was sold for 1 pound to HSBC (yes one pound, because HSBC will handle all the problems & liquidity issues in the british arm of the bank) and yet FDIC is still seeking for potential buyers in US. 

Here as normal people,  we should be awake and:

1-keep our eyes open on our used banks stock price where we hold our money, any sudden massive drop might be a sign of leakage about big problem.

2-keep in mind that ANY downgrade from Moody’s, S&B or other big agencies will have a massive effect and may create similar panic and bank run, if these “evils” downgrades your bank, get your money OUT immediately.