Understanding the SVB Collapse and its Implications
It took 48 hours for Silicon Valley Bank (SVB) to collapse.
Last year, it closed with a valuation of $209 billion, and was the 17th largest bank in the USA – so how did it spiral into chaos and shut down in just two days?
Read on to understand exactly what happened, find out how this may affect you, and what our advice is to ride out the storm.
Why SVB collapse happened?
In 2020-21, when the US government lowered interest rates to support the economy during the covid-19 pandemic, SVB invested in long-term bonds and was enjoying returns to the tune of 1.79%.
However, these bonds locked in their investments for terms of 5-10 years.
Things took a turn last year when the government rapidly began increasing interest rates to combat inflation. This brought down the value of the bonds SVB had invested in – reducing their returns and affecting their cash flow.
At the same time, the economy was experiencing other effects of rising interest rates. Investors generally see these periods as high risk, and so they are more cautious about offering up venture capital as freely. Since tech companies often rely on venture capital to fund their operations, the rise in interest rates made it harder for them to get the funding they needed. This was especially true for SVB, which primarily serves clients in the tech industry.
According to their website, SVB services more than 50% of US venture-backed tech and life science companies, and eventually, once the venture capital investment began to slow, these startups had to start withdrawing their deposits to maintain liquidity and keep their businesses running.
The combination of businesses withdrawing money and reducing the bank’s liquidity as well as lowered returns from its investments put SVB in a precarious position.
They revealed on Wednesday that they had sold assets at a loss as well as announced a stock sale. This sent the market into a panic, with entrepreneurs queuing up to withdraw funds rapidly. Since banks have only a limited cash reserve available for withdrawals (the Federal Reserve currently does not require that banks have any reserve), and with the rest invested in securities and bonds to earn interest, when a large number of people withdraw hefty sums of money all at once, the bank runs out of money and faces insolvency.
This is what led to regulators shutting SVB down on Friday.
Whom will this affect?
Anyone who trades or invests in US shares and stocks is bound to have some indirect exposure, but it likely won’t be a major hit as regulators have swooped in, assuring businesses that they will have all their deposits returned by Monday.
Startups in countries like India, that rely greatly on US-based businesses as clients, may also experience some impact.
In the UAE, some investors see an opportunity to buy out promising but cash-strapped startups. However, as the Dirham is pegged to the dollar, any volatility in the US market is likely to have an effect here – albeit small at this point.
The most substantial impact is the panic that this incident has created. We will also need to keep a close eye on how the US government and regulators will work to contain the damage and avoid a domino effect on other financial institutions as well as the economy as a whole.
As financial advisers who take a long-term approach to building portfolios, we would advise investors to evaluate their risk exposure to the tech industry.
On the back of the SVB and subsequent Signature Bank collapse, as well as the latest round of layoffs that Meta and Google just announced, it’s wise not to put all your eggs into the tech basket as the industry is clearly in a phase of uncertainty and change.
Any healthy portfolio should be diversified with the intent of creating stability and increasing its profitability.
There’s no risk-free way to invest your money. These recent events are proof enough that risks extend to bank deposits as well. Even if it’s not as extreme as a bank collapse, inflation and constantly changing regulations are always eroding the value of your bank deposits.
That’s why we take an evergreen approach to wealth management – invest for the long term, diversify your portfolio, and hire seasoned professionals to manage your money.
This approach helps safeguard our clients’ wealth even when markets freefall and banks go under.
Get in touch with us and talk to one of our experts about evaluating your exposure and diversifying your portfolio to strengthen it in periods of volatility.