[Seungseop Song's Financial Light] How Did SVB End Up Bankrupt?

Invested in US Treasury Bonds with Deposits at SVB
Bond Values Plummet as Interest Rates Rise
Losses Increase While Returning Deposits to Customers
Bank Run Erupts Amid 'Cash Shortage' Rumors

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The bankruptcy of Silicon Valley Bank (SVB) on the 10th has intensified financial instability worldwide. Not only the United States but other countries are on high alert to contain the ripple effects. How did SVB, the 16th largest bank in the U.S., end up closing its doors?

SVB Invested in U.S. Treasury Bonds Using Customer Deposits

[Image source=Reuters Yonhap News]

To understand the reason, we first need to know about SVB. SVB is a bank that started in Silicon Valley, California, USA. It is somewhat different from a typical bank. Instead of serving the general public, it targets startups. It grew rapidly by attracting deposits from startups in the region and had over 2,500 venture capital firms and 44% of healthcare and tech startups as customers.

The collapse of such a large bank is closely related to the Federal Reserve's (Fed) interest rate hikes. Generally, when the benchmark interest rate rises, loan interest rates increase, and banks benefit from a wider interest margin. However, if rates rise too much, fewer people want to borrow money. SVB was no exception. Business slowed down, and with high loan interest rates, Silicon Valley companies were reluctant to borrow, leading to deteriorating profitability.

Therefore, SVB began investing the deposits entrusted by its startup customers. Specifically, it invested in U.S. Treasury bonds. It purchased securities called Available-for-Sale (AFS), which are securities bought with the intention to sell before maturity. SVB bought a large amount of AFS mostly composed of U.S. Treasury bonds. They probably thought there was no risk. As long as the U.S. does not collapse, they would get back the principal and interest. Other banks were also already investing in U.S. Treasury bonds.

Bond Values Plummet as Interest Rates Rise... Losses Reach $1.8 Billion

[Image source=Reuters Yonhap News]

However, problems arose. Startups, facing financial difficulties, began requesting SVB to return their deposits. Just like you withdraw money from your bank account when you need cash, startups did the same. They intended to withdraw money from the bank to use where needed.

But SVB had no cash. They had used customer deposits to buy U.S. Treasury bonds. You might ask, can't they just sell the U.S. Treasury bonds to raise cash? Yes, they did. SVB sold the U.S. Treasury bonds they had purchased to provide withdrawals to startups. At this point, neither the U.S. financial market nor startups realized that SVB was starting to have problems.

In fact, SVB suffered huge losses in the process of buying and selling U.S. Treasury bonds because interest rates rose sharply. To explain, bond prices are inversely related to interest rates (yields). When interest rates are low, bond prices are high; when interest rates rise, bond prices fall. Imagine a bond that pays back 1.2 million KRW in one year. If the market interest rate is 20%, the bond's value might be around 1 million KRW. But if the interest rate rises to 30%, people would trade this bond at about 900,000 KRW. So, as the interest rate rose from 20% to 30%, the bond's value dropped from 1 million KRW to 900,000 KRW.

In other words, when SVB bought U.S. Treasury bonds with customer deposits, interest rates were low (bond prices were high), but when they sold the bonds to return deposits, interest rates had surged (bond prices had plummeted). They bought high and sold low. The losses SVB incurred are reported to be close to $1.8 billion. This is an astronomical amount, easily exceeding 2 trillion KRW.

Rumors of 'SVB Has No Money' Trigger Bank Run

On the 13th, customers and shareholders lined up long at a branch of SVB Bank. [Image source=AP Yonhap News]

Of course, SVB did not collapse immediately. To cover these losses, SVB attempted a rights offering. A rights offering is when a company publicly issues shares to raise funds necessary for management. In other words, SVB tried to raise money by issuing more shares. Naturally, shareholders wondered why SVB was attempting a rights offering. During this process, shareholders learned that SVB was short on cash. As the rumor spread rapidly, the stock price plummeted, and companies that had deposited money in the bank became anxious and started withdrawing their deposits. A 'bank run' occurred.

Eventually, on the 10th, the California Department of Financial Protection and Innovation closed SVB. The Federal Deposit Insurance Corporation (FDIC) was appointed as the bankruptcy receiver. On the 17th, SVB Financial Group, SVB's parent company, filed for bankruptcy protection. Bankruptcy protection is a process where, with court approval, a company temporarily suspends debt payments and attempts to normalize through asset sales. According to major foreign media, SVB's bad assets are estimated to be between $60 billion and $120 billion. This is the largest scale since Washington Mutual filed for bankruptcy protection after its subsidiary bank collapsed during the 2008 financial crisis.

Aside from interest rate hikes, there are criticisms that warning signs were not properly detected. The bank rapidly expanded its size and made large-scale investments using customer deposits, yet no one noticed. In fact, at the end of last year, SVB was the bank that borrowed the most from the Fed. The Fed is usually considered the last resort for liquidity, indicating that SVB's condition was already poor at that time. The relaxation of strict financial supervision standards from assets of $50 billion or more to $250 billion or more has also come under scrutiny. Because of the higher threshold, SVB was able to avoid stringent supervision.