Why did Silicon Valley Bank Fail?
Summary
TLDRThe video script delves into the collapse of Silicon Valley Bank, highlighting a critical oversight in risk management. It explains the bank's business model, centered on tech startup deposits and long-term bonds, and the resulting maturity mismatch. The script outlines how rising interest rates led to a bank run, as the bank's liquidity reserves were insufficient to handle rapid deposit withdrawals. The bank's failure to assess interest rate risk accurately and the absence of a chief risk officer contributed to its downfall, illustrating the fragility of the financial system.
Takeaways
- 🏦 Silicon Valley Bank (SVB) had a specialized business model catering primarily to technology startups, which made up the majority of its deposits.
- 📈 From 2018 to 2021, the bank experienced rapid growth in deposits as tech startups flourished, leading to an increase in the bank's asset holdings, particularly long-term government and mortgage bonds.
- 🔄 The bank's strategy involved a maturity mismatch, where deposits could be withdrawn at any time, but a significant portion of its assets were tied up in long-term bonds.
- 📉 Rising interest rates from 2021 to 2022 caused a decrease in the market value of bonds in the trading book and a reduction in the present value of bonds in the banking book.
- 💡 The concept of interest rate risk in the banking book was highlighted, explaining how bonds held to maturity can still be affected by market interest rate fluctuations.
- 💸 Tech startups faced funding difficulties due to high interest rates, leading them to withdraw their deposits from SVB, which in turn reduced the bank's liquidity reserves.
- 🚨 As liquidity reserves dwindled, SVB was forced to sell off its long-term bonds at a loss, due to the market value being lower than the purchase price.
- 💔 The losses from selling bonds at a loss wiped out SVB's equity, signaling financial distress and prompting a bank run.
- 📉 The bank run on March 8th saw a massive withdrawal of funds, which SVB could not cover with its liquidity reserves, leading to its failure.
- 🛑 The script suggests that SVB's downfall was due to a lack of understanding and management of interest rate risk, as well as liquidity risk.
- 📋 The absence of stringent regulatory requirements for banks of SVB's size and the lack of a chief risk officer during a critical period contributed to the bank's inability to manage risks effectively.
Q & A
What was the primary business model of Silicon Valley Bank?
-Silicon Valley Bank's primary business model was to cater to Silicon Valley startups, with most of its deposits coming from these technology companies rather than private individuals.
What type of assets did Silicon Valley Bank hold on its balance sheet?
-Silicon Valley Bank held a significant amount of government bonds and mortgage bonds on its balance sheet, with these bonds having a maturity of 10 to 30 years.
How did the deposits at Silicon Valley Bank change from 2018 to 2021?
-The deposits at Silicon Valley Bank grew rapidly from 2018 to 2021 due to the success of the startups, which led to an increase in the amount of money they deposited into the bank.
What is the concept of maturity mismatch and how did it apply to Silicon Valley Bank?
-Maturity mismatch refers to the situation where the bank's liabilities (deposits) can be withdrawn at any time, while the assets (bonds) are tied up for a long period, creating a liquidity issue. Silicon Valley Bank faced this issue as it held long-term bonds while having to meet short-term deposit withdrawal demands.
What is the standard formula for valuing a bond, and how does it relate to market interest rates?
-The standard formula for valuing a bond is to take the future payment and divide it by (1 + the market interest rate). As market interest rates rise, the present value of bonds falls, which can impact the bank's asset valuation.
What are the two main risk factors that were relevant for Silicon Valley Bank?
-The two main risk factors for Silicon Valley Bank were interest rate risk in the banking book and liquidity risk.
How does interest rate risk in the banking book affect a bank's assets?
-Interest rate risk in the banking book affects a bank's assets by changing the present value of the bonds they hold. If interest rates rise, the present value of these bonds falls, which can lead to losses if the bank is forced to sell them before maturity.
What is liquidity risk in the context of banking, and how did it impact Silicon Valley Bank?
-Liquidity risk in banking refers to the risk that a bank may not have enough liquid assets to meet its short-term obligations. Silicon Valley Bank faced liquidity risk when startups withdrew their deposits rapidly, forcing the bank to sell its bonds at a loss to meet these obligations.
Why did Silicon Valley Bank need to sell its bonds, and what was the outcome?
-Silicon Valley Bank needed to sell its bonds due to a rapid withdrawal of deposits by startups, which depleted its liquidity reserves. The outcome was a loss on the sale of these bonds, as they had to be sold at market prices lower than their purchase value.
What triggered the bank run on Silicon Valley Bank, and what was the final outcome?
-The bank run on Silicon Valley Bank was triggered by the realization that the bank had to sell its bonds at a loss, which wiped out its equity. The final outcome was the bank's failure due to its inability to manage liquidity and assess interest rate risks accurately.
How did regulatory changes under President Donald Trump affect Silicon Valley Bank's risk management?
-Regulatory changes under President Donald Trump lifted certain banking regulations, including the requirement for banks with a balance sheet under 250 billion euros to perform interest rate risk in the banking book calculations. Since Silicon Valley Bank's balance sheet was around 212 billion euros, they were not required to perform these calculations, which may have contributed to their failure to manage interest rate risks.
Outlines
🏦 Silicon Valley Bank's Risk Management Failure
The first paragraph introduces the topic of Silicon Valley Bank's collapse, highlighting the bank's flawed risk management. It explains the bank's business model, which was heavily reliant on deposits from technology startups. The bank's balance sheet is discussed, showing a significant portion of long-term government and mortgage bonds as assets, financed by customer deposits. The paragraph also explains the concept of maturity mismatch, where deposits are liquid but the bonds are not, setting the stage for potential liquidity issues.
📉 Impact of Rising Interest Rates on Bond Values
The second paragraph delves into the dynamics of bond valuation and the associated risks for Silicon Valley Bank. It explains how rising interest rates can lead to a decrease in bond prices, which in turn affects the bank's assets. The paragraph further discusses two types of interest rate risk in the banking book: the present value view and the net interest income view. The former assesses the current worth of bonds, while the latter evaluates the cash flow mismatches that could arise from changes in interest rates. Liquidity risk is also introduced as a critical factor for banks, particularly when they invest in long-term assets with short-term liabilities.
💡 Silicon Valley Bank's Liquidity Crisis and Collapse
The third paragraph outlines the sequence of events leading to Silicon Valley Bank's failure. It describes how startups, facing difficulties in securing funding due to high interest rates, began withdrawing their deposits, causing a rapid shrinkage of the bank's liquidity reserves. As a result, the bank was forced to sell off its bonds at a loss, which significantly impacted its equity. The paragraph concludes with the bank's inability to manage the liquidity crisis, leading to a bank run and ultimately, the bank's bankruptcy. It also touches on regulatory changes and the absence of a chief risk officer, which contributed to the bank's inability to manage its risks effectively.
Mindmap
Keywords
💡Silicon Valley Bank
💡Risk Management
💡Balance Sheet
💡Equity
💡Deposits
💡Government Bonds
💡Maturity Mismatch
💡Interest Rate Risk
💡Liquidity Risk
💡Bank Run
💡Chief Risk Officer
Highlights
Silicon Valley Bank's failure was due to a fake layer of risk management.
The bank had a specialized business model focusing on Silicon Valley startups.
Most deposits at Silicon Valley Bank came from technology startups, not private individuals.
The bank's asset side was heavily invested in long-term government and mortgage bonds.
A rapid growth in deposits from 2018 to 2021 led to an increase in bond purchases.
The bank faced a maturity mismatch between short-term deposits and long-term bonds.
Rising interest rates from 2021 to 2022 caused a decrease in bond values in the trading book.
Silicon Valley Bank did not revalue bonds in the banking book to market value, hiding losses.
Startups began to withdraw deposits as funding became difficult due to high interest rates.
The bank's liquidity reserves were insufficient to handle the rapid withdrawal of deposits.
Silicon Valley Bank had to sell off bonds at a loss to meet liquidity needs.
The loss from bond sales wiped out the bank's equity, leading to insolvency.
The bank's failure to manage interest rate risk in the banking book was a key factor in its downfall.
A bank run occurred on March 8th, with 42 billion euros withdrawn, overwhelming the bank's reserves.
The lack of a chief risk officer and relaxed banking regulations contributed to the bank's failure.
Silicon Valley Bank's collapse highlights a failure to manage basic banking risks.
The incident reflects a concerning state of the financial system, where such a failure could occur.
Transcripts
so I'm gonna give you an in-deter view
of why Silicon Valley Bank failed and
you'll understand that it was that this
was an incredible fake layer of the risk
management at Silicon Valley bank so I'm
first going to go over the theory that
we need and then I'm going to go over
the timeline of events and what actually
led to the failure of the bank but let's
look first at the balance sheet of
Silicon Valley Bank so as every Bank
Silicon Valley Bank has equity
it's about 12.5 percent of their balance
sheet and Silicon Valley Bank has
deposits so that's in theory you and me
who can give money to the bank as in a
bank account but Silicon Valley Bank is
specialized on Silicon Valley startups
so here you can actually see how their
deposits are made up and you see that
most of the deposits are technology
startups so most of those deposits
actually come from technology or Silicon
Valley startups that's their kind of
business model so most of the deposits
are not private people but startups with
a lot of money
and on the asset side Silicon Valley had
a lot of government bonds
and so something interesting happened
from 2018 to 2021.
the startups go really well so what
happens is that the startups can raise a
lot of money and put a lot more deposits
into the bank so what happens is that
the deposits grow rapidly in the time
period from 2018 to 2021
and what does the bank do well the bank
has gets money
and they have to pay low interest rates
here so maybe 0.5 percent and they want
to earn money with this so what they do
is they buy more bonds and they buy
long-term government bonds or mortgage
bonds and those bonds are
10 year to 30-year bonds so you get your
money back after 10 to 30 years and they
pay slightly higher interest rates I
think they got about 1.8 interest rates
on those bonds and so you see
that in theory
Silicon Valley Bank makes money right
1.3 percent is the difference between
what they pay on the liability side and
what they get on the asset side but
there is a catch here there's a maturity
mismatch
because
the depositors well they can get their
money at any time and the money that is
in bonds that is bound in the bonds so
the bonds have 10 to 30 year maturity so
this money is not very liquid so far so
good because this is the normal business
model of a bank so let's
go a bit into bonds because I need to
explain to you one important concept so
this is for example a one-year Bond you
buy this financial product and you get
105 Euros a year so the question is what
do you have to pay for this Bond today
and the standard formula for valuing
such a bond is to say Okay I I take what
I get in a year and I divide this by one
plus the interest rate on the market so
let's say the interest rate is five
percent what's the value of our bond in
this case it's 100 euros
let's just say the interest rate is not
five percent but ten percent what's the
value of our bond then well the value of
our bond is roughly 95 Euros so what
does that mean well with Rising interest
rates
bond prices fall
okay so let's get into the risk factors
that were relevant for Silicon Valley
Bank and for them there were especially
two risk factors one is interest rate
risk in the banking book and the second
one is liquidity risk let's start with
interest rate risks in the banking book
so to understand what this means we need
to look closer at those Bonds in the
portfolio of Silicon Valley Bank and for
for every Bank there are two types of
assets there are assets in the trading
book
and Assets in the banking book
Assets in the trading book they are held
short term and the bank wants to trade
with them in other words buys them and
wants to sell them in the near future
they are valued to Market so in the
balance sheet they appear on market
value
and the bonds in the banking book the
bank buys them and wants to hold them to
maturity in other words if we have this
one year bond the bank buys it at its
price at the start of the year and then
Waits until the bond pays its final
payment of 105 euros
that is the case so if the bank wants to
hold the bond until maturity then it's
in the banking book and bonds in the
banking book are not valued at market
value but at purchase value
so in other words if if Silicon Valley
Bank would plan to sell the bond in the
middle of the year it would be in the
trading book and it would appear with
market value on the balance sheet if
however Silicon Valley Bank plans to
hold the bond then it is in the banking
book and it will appear with purchase
value
and
even with Bonds in the banking book
there is risk and this risk is called
interest rate risk in the banking book
and this risk is typically measured in
two ways in the present value way and in
the net interest income way I have made
a detailed video on interest rate risk
in the banking book and here's only a
short overview so what is the present
value view well the present value view
looks at all the payments that are
coming from the bonds over time so this
may be year one year two year three and
gear 4. and it asks okay what are those
bonds worth today
why is this an important question well
even if I do not plan on selling my
bonds sometimes it can be sometimes I
may be forced to do it maybe the owners
of the bank want to shut shut down the
bank right now
then they have to sell all the assets
even the ones in the banking book and
that can be unforeseen so it's important
to understand what is my portfolio worth
today and that is what the present value
approach looks at the second approach or
the second approach in interest rate
risk in the banking book is so-called
net interest income approach and the net
interest income report approach I also
look at the time axis but I look at the
following I look at how much interest I
have to pay for my liabilities so that's
the interest I have to pay and I look at
how much interest I get from my bonds
and maybe if the interest that I get for
my bonds is plus 100 but I have to pay
minus 50 on the liability side in year
one then I'm fine
and I do this for every year in the
future
so I always look at what what comes in
what goes out and do they match and it
might be that I identify a mismatch so
that I only get 50 euros for my bonds
but that I have to pay
100 on my
interest and if I have identified such a
problem well I need to take measures for
instance hold more cash or do other
things
okay so this is the net interest income
View and the second risk that is
important for Silicon Valley Bank is the
liquidity risk
um the example I always like to give to
give is well let's just think about the
CEO sits in his office and he has to pay
the janitor and there's a Picasso on the
wall but he has forgotten his wallet
then he can't pay the January although
he technically has the money so he's ill
liquid and that's classical liquidity
risk and banking that is typically the
case when a bank gets money from
people
so from individual depositors
and puts the money in a 30-year mortgage
then the depositors can get their money
anytime but the money and the mortgage
is Bound for maybe 30 years so that's
where liquidity risk comes from in
banking
so now that we have the basics down I've
talked about the balance sheet of
Silicon Valley Bank I've talked about
bonds and I've talked about interest
rate risk and liquidity risk we can
actually understand what happened at
Silicon Valley Bank so I already told
you that in their balance sheet they had
their equity
and they had the deposits which were
rapidly growing from 2018 to 2021
and you had a lot of bonds
on the asset side and a lot and most of
those Bonds were part of the banking
book
and some of those bonds are part of the
trading book
so now in 21 21 to 2022 interest rates
start Rising that means that our bonds
in the trading books start to lose in
value
so some of the value here gets lost
however Silicon Valley Bank does not
have as much Bonds in the trading book
so that's not really a problem
on the balance sheet you do not really
see a loss in value for Bonds in the
banking book because they are not
revalued but you see a loss in present
value of the bonds
so the present value of the bonds goes
down
this is what you see in your interest
rate risk in the backing book
calculations but you will not see this
on the balance sheet because the ones in
the banking book are not marked to
market value
then what happens in the beginning of
2022 that a lot of the startups have
trouble to get funding
why because they have high interest
rates and they do not want to get
additional funding at those High
interest rates so in order to get money
what they do is they use their deposits
so what happens is a lot of the
companies that have that have their
money at Silicon Valley Bank start to
withdraw it from their accounts so the
deposits start to shrink
and now comes the big problem as the
deposits shrink very rapidly the
liquidity reserve of the bank which is
usually only a very small part of the
asset side usually it's two percent of
the portfolio so
very roughly Silicon Valley Bank had a
200 billion dollar portfolio so you
would expect that their liquidity
Reserve is at
um 4 billion
so what happens is as a lot of the
startups withdraw their deposits their
liquidity Reserve gets
um gets used
and they have to sell Bonds in the
banking book
and of course if they have to sell those
Bonds in the banking book they have to
sell them to the market but of course
when you sell those bonds you have to
sell them at market price so what
happens is they lose money of those on
those bonds because they have those
bonds at purchase price in the balance
sheet but they have to sell at market
price and with Rising interest rates
those bonds are worth a lot less so what
happens is they sell those bonds they
make a loss and this loss basically
wipes out all their Equity so that's bad
the bank bank doesn't have Equity
because it has made a lot of losses on
selling those bonds
so what does the bank do well the bank
says oh we need new Equity so we need
investors to get equity and what happens
then is people start to realize that
and what happens on 8th of March is that
42 billion billion euros
are withdrawn from the bank and as I've
told you the liquidity reserve of a bank
is usually two percent of the balance
sheets so in the case of Silicon Valley
Bank 4 billion there's no way that
Silicon Valley Bank can unravel their
assets that fast
and with this Bank Run the bank goes
bust
so to summarize why this happened is
basically because Silicon Valley Bank
didn't understand their interest rate
risk in the banking book and because of
the unfolding interest rate risk because
of the higher interest rates a bank run
came and they could not manage liquidity
so in other words their failure in the
end was a fair year of liquidity but it
was caused by Rising interest rates and
a failure to accurately assess interest
rate risks they did not pay enough
attention to the loss and present value
of their portfolio
and
this is what basically
brought them to fall down because they
had to sell a lot of those assets at a
lower present value they had a lot of
junk risk in those bonds and they did
not hedge that risk accurately
in my opinion
the sad thing here is that President
Donald Trump
actually had lifted banking regulations
while banks have to do interest rate
risk in the banking book until 2018 in
2018 Donald Trump said well we only
required this for banks with an asset
with a balance sheet larger than 250
billion euros the balance sheet of
Silicon Valley Bank is at about 212
billion euros so they did not have to do
those calculations also they did not
have a chief risk officer during that
time because their Chief risk officer
left and they took about six to eight
months to hire a new one so what Silicon
Valley Bank actually did is they failed
to manage one of the most basic risks in
banking and I think this is a very very
sad picture of the state of the
financial system that something like
this
can happen
Weitere ähnliche Videos ansehen
Japan’s Banking System Collapsing! HUGE Bank JUST FAILED! $1.1 Trillion at Risk!
MIGLIORI CONTI DEPOSITO di SETTEMBRE 2024 prima del taglio dei tassi + file di simulazione
This Globally Systemic Bank Just Went Into Crisis Mode (Derivatives)
Meezan Bank is not Islamic? | Islamic and Conventional Banks | Saving Account | TheLightofGuidance
Role of the Central Bank
Awal Lembaga Perbankan di Indonesia
5.0 / 5 (0 votes)