On March 10, 2023, Silicon Valley Bank (SVB) based in California filed for bankruptcy. The news was a true surprise as it took little time for the bank to collapse. Because the bank was 16th largest in the U.S. and because billions of dollars were at stake, many feared that the impact of bank closure would hit hard on the worldwide financial market. What exactly is SVB, and how did such a large bank go bankrupt so quickly?
As its name indicates, SVB was set up to mainly support venture companies based in Silicon Valley. The bank had assets that exceeded $200 billion, and its bankruptcy is the second largest one in the history of United States. SVB made profits from the spread between deposits and loans, from investing in venture capital, and from collecting transaction commissions. The bank would give unsecured loans to startup companies, and would collect deposits from those working in Silicon Valley. A large part of the deposit services to startup companies were non-interest bearing deposits.
When the COVID-19 pandemic hit the world hard in 2020, there was a liquidity crisis. There was a vast surplus of cash in the market, and one could easily obtain loans that had interest rates close to zero. As a result, venture capital and startup companies were able to have plenty of cash, and these two important customers no longer needed loans from SVB. As the bank had fewer chances to make profit, SVB tried to seek other options. The following is the summary of steps that resulted in the bankruptcy of SVB.
1. As fewer companies took loans from the bank, SVB started to invest into long-term bonds.
2. The bank owned the bonds ($21 billion dollars’ worth) for more than three years, but yielded little profit. In fact, it resulted in a loss of $1.8 billion.
3. As the interest rate kept going up, startup companies took out their deposits in search of higher interest rates, and this greatly reduced balance.
4. The bank decided to take loss of $1.8 billion while selling $21 billion dollars worth of bonds. The bank notified the share holders of the decision to sell the bonds.
5. Owners of venture capitals and shareholders started taking out their deposits from the bank, and this resulted in panic. Other customers followed, and this resulted in SVB going bankrupt within two days.
What is the impact of SVB closure on the financial markets in Korea? Experts say that its impact would be limited because of two reasons. First, banks in Korea are able to take temporary losses, are financially sound, and have a positive liquidity portfolio. Korean banks make profits mostly from the spread between deposits and loans. Their Liquidity Coverage Rates (LCR) exceeds more than 100%, and their LCR in foreign currency is at 143.7%. Second, banks in Korea are run very differently compared to SVB, and have an entirely different asset and debt structure.
Some experts feel that this may even have positive effects on Korea’s economy as the Federal Reserve Board may stop hiking up interest rates to reduce the impact of financial crisis. As interest rates slowly declines, it may help stabilize financial markets. However, one should observe the situation very carefully as it may have ripple effects as time goes on.
By. Ian Kang