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Why did Silicon Valley Bank collapse? Is First Republic next? Expert explains.

2023-03-14

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As the fallout from the collapse of Silicon Valley Bank still unfolds, many customers of other regional and mid-sized banks, such as First Republic, are wondering how a bank run like the one that just occurred could happen. And, more importantly, are wondering if it could happen again to their bank.

Rodney Ramcharan, a professor of finance and business economics at USC Marshall School of Business, says the fallout of SVB's collapse could impact other banks, but that it is unclear if what caused SVB's collapse could happen at other banks.

What started the bank run at SVB was, first, the bank was exposed to the interest rate increases put out by the Federal Reserve starting last year, as it invested much of its deposits from the tech industry into long-term treasury bonds that decreased in value after the rate hikes.

Then, over time, depositors began withdrawing some funds, forcing SVB to sell its bond holdings at a loss.

As SVB began taking on these losses, depositors at the bank began to question the solvency of the bank, causing them to withdraw more funds to avoid the loss of their money if the bank were to collapse.

As more people withdrew funds from SVB, the more bonds the bank had to sell at a loss.

"Again, it's selling safe assets, but it is selling them at a loss because the value of the assets has gone down because of the interest rate increase the Fed has put in place in the last year or so," said Ramcharan.

Ramcharan also said that the current bank crisis is different from the bank collapse of 2008 because in that situation, banks had invested in unsafe assets called subprime mortgages. In the case of SVB, the bank invested in what is considered a safe asset: U.S. treasury bonds.

Also different from the 2008 financial meltdown, the federal government has said it will bail out depositors from collapsed banks, and not the banks themselves.

"I think that the government, and the Fed, has issued almost a blanket statement, so that deposits are safe," said Ramcharan. "The government has signaled, such is the case of SVB or smaller banks, that if they were to get in trouble, the government is prepared to bail these banks. Not bail them out, but bail the depositors out. Even those with deposits in excess of $250,000."

It is the $250,000 limit on insured deposits by the FDIC that in part caused customers to pull their money out of SVB, leading to the collapse last week.

As for whether the Fed will continue to increase interest rates as scheduled next week, Ramcharan said the Fed is unlikely to continue the increases as planned.

"I think the bond market today seemed to have taken the view that the Fed will slow the pace at which it is going to raise rates. It's difficult to forecast what exactly the Fed will do, but the one thing that we can say is that the likelihood of a 50 basis point (0.5%) hike has gone down a great deal."

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