The Silicon Valley bank crisis caused quite a stir. I am not a bank failure analysis professional. Nonetheless, there are lessons in personal finance to be learned from all of these financial disasters.
As I’ve already said, I lack the expertise to write a thorough post or express my opinion about the Silicon Valley bank crisis. Yet as a human, I can read and understand to some degree.
Explaining the Silicon Valley Bank Crisis
Let me first explain in a simple way how this crisis came about.
# SVB was founded in 1983 and was the 16th largest US bank before its collapse.
# SVB is specialized in banking and finance startups and most of the tech companies.
# SVB was a preferred bank for these start-ups as bank backed startup companies which not all banks would accept due to high risk.
# Banks get money in the form of current account balance, savings account balance, fixed deposit or recurring deposit.
# As they promised to pay you fixed interest (except current account), they have to invest or lend this money somewhere to give you the promised interest and principal back safely.
# Let’s say FD is at 8%, then banks have to invest or lend to anyone where their earning potential is more than 8%.
# Due to the boom in IT during the Covid period, these tech start-ups received a lot of cash as consumers started spending on digital services and electronics.
# Since SVB was the preferred choice for all these startups, most of these startups put their money with this bank. Between the end of 2019 and the first quarter of 2022, bank deposits more than tripled to $198 billion. However, during this period, the industry’s deposit rate was around 37%.
# However, the percentage of borrowers did not decline significantly during this period.
# Because of this, since banks cannot keep depositor’s money idle, about 15% was lent, and the remaining 85% was invested in a portfolio of securities or held as cash. About two-thirds of the deposits were non-interest bearing demand deposits and the rest offered a small rate of interest. Deposit rates were around 1.17%.
# The bank invested this money in AFS (Available for Sale) securities and HTM (Hold to Maturity) securities. AFS securities mean that the holders can sell the securities before maturity. However, the selling price depends on the rate at which the bond is trading. However, in case of HTM, you intend to hold till maturity. Hence, you do not have to worry about the volatility of the price in the secondary market. But since you cannot sell before maturity, your money is locked in.
# It adopted a two-pronged investment strategy: to shelter some of its liquidity in short-term Available for Sale (AFS) securities while accessing returns with longer-term to maturity (HTM).
#Now the real matter begins. As inflation skyrocketed in the United States and indeed around the world, interest began to rise. Because of this, bond prices turned negative, and especially long-dated bonds.
# Without diversifying the portfolio, without analyzing the immediate short-term requirements of the bank, SVB invested, shifting the money into long-term securities. Due to this, there is a huge increase in unrealized losses from zero in June 2021 to $16 billion by September 2022. The smaller AFS book was also impacted, but not as badly.
# This drop in value was so great that Silicon Valley Bank was technically insolvent in late September.
# To fund it or not, when SVB announced its $1.75 billion capital raise on March 6, people became concerned that the bank was short of capital. Word spread and customers began withdrawing money in waves.
# If the bank has to fund the depositors, it has to sell the securities in the secondary market at a discounted price. As inflation and interest rate cycles caused the price to fall drastically, the loss was too large for the bank to recoup.
#California regulators finally closed the bank on March 8 and placed SVB under the FDIC.
This is the story that I have understood to the best of my limited ability and knowledge. However, I may be wrong, and correct me if I am wrong in my knowledge. Because the purpose of this post is to discuss what we can learn about our money from such bank failures than to dig deep and research about what caused the failure of SVB.
The Silicon Valley Bank Crisis and Learning Personal Finance #Banks Are Run by Humans
You must accept that banks are managed by human beings and there is a high probability that mistakes will be made. Reasons for failure may vary. However, we cannot completely avoid the crisis. There have been many such banking collapses throughout history, and there may be more in the future. So, despite the sanctions, we have to be prepared to experience such banking failures.
# Your deposit is unsecured
Deposit up to Rs. 5 lakhs are the only ones who are insured as per Indian banking. Besides, it isn’t. So, you must first understand this basic concept. Still, if you want a completely safe facility for your FD or RD then parking at the post office is the best option as post office products are sovereign guaranteed.
# Diversification is a mantra
The primary reason for the downfall of SVB was its excessive exposure to one class of assets. This resulted in a complete mess in handling a diversified investment or lending strategy. To reduce the chances of failure, we as an individual should always diversify our investments. If you have a large sum of money to deposit, split it among family members or multiple banks.
Concentrated investing is always risky.
#Risk can’t be avoided
It does not matter whether we invest in any type of investment like FD, Debt Fund, Bond or Stock, we cannot completely eliminate risk. As a result, the only way forward for all of us is to manage rather than avoid risk.
In fact, keeping money in your savings account or in your home in cash mode is also risky (which many people are unaware of).
# Debt investment does not mean it is safe
We have the mindset to believe that equity is risky but debt is not. Looking at the current state of SVB, you will find that loan also has its own risks like default risk, credit downgrade risk, interest rate risk or reinvestment risk.
So never think that debt portfolio is safe. Debt portfolios can also carry significant risk if you don’t know what you are doing.
# Choosing the right debt instrument
Not all loan products are equal. They take different risks. Therefore, it is very important to understand the risk. For example, by investing in government bonds or gilt funds, you can completely avoid default or credit downgrade risk. However, you cannot avoid interest rate risk. Hence, it is better to choose a risk product based on your requirement instead of investing indiscriminately.
# Never chase returns from loans
Investors run after yield even in debt portfolios. The classic example is the failure of Franklin. However, this comes with great risks. If you are really interested in taking on risk, it is far better to increase your equity allocation than invest in a low-rated and high-yielding debt portfolio.
Conclusion – The Silicon Valley bank crisis is more than an American crisis, but bad news about it can have global ramifications. Its effect on Indian banks may be nil. Nevertheless, a global panic situation may develop. Like Yes Bank, PMC Bank or other cooperative banks, we too have experienced banking failures. The reasons may be different. Additionally, tighter RBI regulations may prevent a major banking crisis from occurring. But we also need to be mentally prepared.