Two of America’s major banks have collapsed. California’s Silicon Valley Bank and New York’s Signature Bank. This is said to be the second biggest banking failure in American history. The 2008 collapse of the Washington Mutual Bank was the biggest. It was followed by the 2008 financial crisis. Bringing a global recession as was seen after the 2008 Financial crisis because beleive this or not, that 2008 crisis still Affects you !! But how was that collapse Happened ?

It happened because of the downfall of Real Estate Market. And even nowday’s the increased prices of Food items, Daily Essential items , Cars , Petrol has increased more than 5 percent than it was before the crisis of 2008 !! Even the stock market was badly Affected from that crisis !!

What Exactly Happened for the collapse ?

People are worried that this banking collapse might create another recession like in 2008. Because if America’s financial system crashes, the impact can be seen all over the world.

What happened exactly and How did it happen?

Silicon Valley Bank collapsed on Friday. The collapsed Silicon Valley Bank is causing shockwaves across the entire business world. Silicon Valley Bank”

It is the epicentre of tech startups, venture capitals. The collapsed bank had invested in around 21 Indian startups. The bank stock lost 80% of its value this week a total of 60% in one day alone. However The President of United States Joe Biden stated in a press conference that The management of these banks will be fine.Investors in the banks will not be protected.”

How Banks Earn Money – The Business model of Banks

To understand this situation, We need to first understand how banks work. From the perspective of an individual, Bank is the place where we keep our hard-earned money. We deposit our money with the banks for safekeeping. But from the perspective of a bank, the bank is running a business. They won’t work for you for free. Banks have a distinct business model. The money deposited by you with the banks, banks would want to use it to make money for themselves. There can be different ways of making money. For example, giving loans to other companies and individuals. The interest charged on that loan would be the profit for the bank. The second source of income is investing in various places. Banks invest the money deposited with them in the stock market, government bonds or for buying gold for example.

Similar to how individuals invest their money at various places, Banks can do the same to earn more money.

How was SVB Started !!

The bank was established in 1983. Its headquarters are located in Santa Carla, California. And initially, this bank invested a large chunk of its money into real estate. In the early 1990s, half of this bank’s portfolio, was made up of the real estate property business. Well what is Portfolio ? Your answer is – All your investments are collectively known as a portfolio. Every person has a portfolio. Any investment into stocks, gold, or even in cash, makes your portfolio. You would have seen financial experts advise that every portfolio needs to be ‘diversified’. One shouldn’t invest all the funds into a single asset.It is highly risky. Suppose you use all your savings for buying gold. Since someone told you buying gold is a good investment option. And then one day, the gold market crashes.

What would happen to you? Your savings turned into dust !

Something similar happened to SVB back then. 50% of their portfolio was real estate investments and in 1992, California’s real estate market crashed terribly. Due to this, the bank had to incur a loss of $2.2 million. After this, the bank realised that they need to diversify their portfolio, so after 1995, the contribution of the real estate business has remained around 10%.

Why did I tell you this?

Because the bank is going through a similar thing. but on a much larger scale moving on from 1995 to the 2000s, the bank was known for a new thing. This bank was heavily investing in startups. Especially, technology-based startups.

The technology-based companies that were in the venture stage, the bank would give loans to those companies specially. By 2015, the bank had expanded so much, it was reported that 65% of all startups in America were served by this bank. The companies in the tech industry were the biggest customers of SVB. The name fit the bank very well. The technology-based companies in Silicon Valley, were banking with the Silicon Valley Bank. In this aspect, the SVB was quite unique. It was working almost exclusively for technology-based startups. But the other banks look for diversified customers to give loans to.

But this wasn’t the case for SVB. By the end of 2022, SVB was the 16th biggest lender in America. With the value of its total assets at $209 Billion.

How Silicon Valley Bank Crashed !

Friends, the problems began with the Covid-19 pandemic. With global lockdowns, venture capitalists from all over the world, began investing in software companies. People saw that even during the lockdown when everything else had to shut down, software-based companies are the most successful. That run through computers and mobile phones. This is why in 2021, the startups raised a lot of money. In America, $330 Billion was raised in total almost double the record of the previous year. If these technology-based startups have so much money, they would want to deposit the funds with the bank.

And SVB was the #1 preference of technology-based startups. This is why in March 2021, the value of the total deposits with the bank was around $124 Billion. It was at $62 Billion the year before. A 100% increase. This was a huge jump with so much money being deposited into the bank suddenly.

If we Compare this to the other banks,

They did not see such a large jump. For Example , JP Morgan Chase Bank saw an increase of 24% only. Since the bank had so much money in the form of customer deposits, They decided to use it to make even more money. So SVB used the billions of dollars, To invest in government bonds. SVB bought a large number of bonds at a time when the prevailing interest rates in the market was quite low. According to America’s Federal Reserve, the interest rates were around 0%-0.25%. (Extremely low)

HOW EVERYTHING CHANGED ?

It was expected that the interest rates would remain low, But this didn’t happen. The interest rates increased. Without going into too many technicalities, All you need to understand is that bond price and interest rate have an inverse relationship. If interest rates go down, bond prices go up. The longer period you hold the bond, the riskier it becomes the interest rates can fluctuate while you’re holding onto it, the price may fluctuate.It might benefit you or may cause you losses.But if the price of the bond you’ve bought falls, you will have to bear the losses. This turned into a worst-case scenario for SVB. The American government increased the interest rates. By raising the interest rates, the value of the bonds held by SVB crashed. They suffered a huge loss. But this wasn’t the only loss. The second negative impact was even greater. By increasing the interest rates, the interest rate on borrowing loans increases as well.

For startups and companies, taking loans became more expensive. So they would avoid taking loans. What else could they do to meet the funding requirements? They would use the money they have deposited into the banks. By 2022, after the interest rates had increased, the tech startups wanted to withdraw their deposits to meet financial needs. Venture capitalists weren’t funding them anymore. Since they had their deposits with SVB, they wanted to make withdrawals at the same time, it became problematic for the bank because the bank didn’t have enough funds to Fulfil the withdrawl requests , which cause the crash of America’s Silicon Valley Bank !!

Billionaire Elon Musk on SVB Crash !

Elon Musk Former ceo of Tesla (World’s Largest Electric Automobile Company ) who is currently owner and ceo of Twitter has also Tweeted that he will buy SVB ! Well we are not sure whether he is sure or he is just creating humour through his Tweets like he always does !!