The recent sudden collapse of Silicon Valley Bank (SVB) has shown how poor risk management can bring down an entire bank, dispelling the belief that bankruptcies only happen in movies. Founded in 1983, in Santa Clara, California, the bank had become the 16th largest bank in the US, with total assets of $209 billion, by specializing in technology and lending money to emerging start-ups in Silicon Valley.
The COVID-19 pandemic has had a significant impact on the economy, and governments around the world have responded with measures such as quantitative easing to stimulate economic growth. In the US, a total of $4.6 trillion was spent in response to COVID-19, which included providing financial assistance such as grants, loans, and relief funds to support unemployment and decrease demand during quarantine.
As the pandemic recedes, governments are grappling with the consequences of their actions—inflation. The growth in the quantity of money has led to inflation, i.e., an increase in overall prices. While inflation can have negative effects, such as reducing the purchasing power of money, it is seen as necessary to avoid unemployment. In other words, an increased amount of money leads to inflation but also increases the demand for goods and services, thereby leading to more supply and hiring.
The inflation rate is measured by the Consumer Price Index (CPI), a measure of the overall cost of goods and services bought by a typical consumer. Hyperinflation decreases purchasing power and, therefore, makes it harder to maintain a decent living. In the US, the CPI marked its highest point in 39 years last December, indicating significant inflation.
To combat the rate of inflation, the Federal Reserve System has announced several increases in interest rates, ranging from small to large. Big steps (a 0.5% increase) and baby steps (a 0.25% increase) have been taken.
Silicon Valley Bank did not prepare appropriately for these changes. Like other banks, Silicon Valley Bank invested its deposits into bonds. Their share of bonds became less profitable as interest rates rose rapidly to fight inflation, making newer bonds more profitable. Additionally, venture capital investing slowed down as investors and start-ups withdrew money. Silicon Valley Bank sold $21 billion of bonds to raise money to repay these withdrawals, raising concerns about the bank's financial stability. This caused a sharp 23 percent decline in the bank's stocks in a single day.
Uncertainty and credibility issues have also played a role in bankruptcies in the past. For example, FTX, one of the largest cryptocurrency exchanges, went bankrupt after the chief executive of Binance, the largest cryptocurrency exchange, questioned the stability of FTX and its tokens, FTT. The price of FTT plummeted, and customers withdrew their money, causing a bank run leading to the bankruptcy of FTX.
Compounding the problem, starting with Silicon Valley Bank, other banks around the world started to collapse. Signature Bank, for example, was shut down by the New York State Department of Financial Services and the Federal Deposit Insurance Corporation on March 12, 2023. The New York-based bank closed two days after SVB. These banks have been affected by several factors including the steep base rate which caused people to rush to withdraw their deposits. For another example, Credit Suisse Bank almost failed. However, fortunately, on March 19, the bank, founded and based in Switzerland, entered into a merger agreement with Union Bank of Switzerland, one of the largest banks. It may seem to have no connection with SVB, but Credit Suisse chairman Axel Lehmann said, “The bank’s fallout still serves as a warning signal for the all-round market climate.” And of course, other banks all around the world like US Bancorp, Wintrust Financial, and so on experienced stock price falls.
The point is that the collapse also raises concerns that rising interest rates could expose weaknesses in the global economy as a decades-long era of low-cost money ends. One effect of this is that people have started to distrust virtual money such as Bitcoin and other new kinds of money. They now prefer real money that we can see, like commodity money and fiat money, since they want to feel safe.
The steps taken to fight inflation have changed the lives of not only Korean people but also everyone on the planet. Owing to skyrocketing inflation, it is not easy to find anything considered cheap. People are trying to save as much money as possible. At the same time, many people worry that a new recession will descend into another Great Depression. If we look back and see what caused the Great Depression, we can see what everything was like and easily identify the contributing factors.
On March 24, President Joe Biden asked people not to worry, saying they are safe. “Americans can rest assured that our banking system is safe—your deposits are safe,” Biden said. The president also said that he will ask Congress and the banking regulators to strengthen rules for banks to make it “less likely this kind of bank failure would happen again.” Well, only time will tell.