SVB Saga Is A Tragedy Of Errors
The primary source of riskiness in banking operations are not necessarily from mass default by borrowers. Even with borrowers repaying their loans as promised, banking structures are inherently an unstable one.
Banks acquire funds through short term deposits while they lend them for longer maturities. This asset liability duration mismatch is not visible to the average investor, but is a powder keg that all banks sit on irrespective of their size. Large banks manage this risk by having a large, diversified base of retail depositors whose funds stays inside the bank for longer terms , that is, sticky.
When movement in market interest rates are smooth and predictable, it is easier for banks to manage asset liability mismatch problems, but in an era of volatile interest rates , it has the potential to destabilize a bank.
Silicon Valley Bank (SVB) depositors were startups and venture capital investors, whose deposits are not as sticky as retail customers. SVB’s past investments of its cash reserves in the US debt markets at near zero interest rates made it an underperformer. With its credit ratings under threat, SVB was staring at a $1.8 billion loss, trying to rebalance its underperforming $21 billion debt portfolio.
The sudden increase in interest rates by almost 475 basis points in a short span of 9 months by the US Federal Reserve decimated the value of its debt securities holdings . It decided to strengthen its balance sheet by raising more equity. Unfortunately, the communication to that effect had the opposite effect, sending a signal to the corporate depositors in the bank that it was in trouble.
An overnight run on its deposits brought SVB to the point of collapse. The simple fact is that SVB failed due to a run on the bank, when the truth is that it was neither insolvent or even close to being so. Banking as an enterprise survives as much on cash as on confidence, and as the latter waned, the former disappeared.
The whole unfortunate saga was a self goal – almost a tragedy of errors compounded by the bank’s own mangled communications, and an overreaction from fidgety depositors in a period of tech meltdown. They pounced upon the bank’s regulatory filings for raising capital as a sign of trouble. The molehill instantaneously turned into a mountain, rather a mighty avalanche that no one could foresee coming.
The author is a Professor and Program Director at Great Lakes Institute of Management, Chennai.
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