When Silvergate Bank and Silicon Valley Bank (the 16th largest bank in USA) collapsed within days last weekend, the regulator stepped in to contain the risk of more bank failures. Contagion spread to other banks like First Republic Bank, Signature Bank, Zions Bancorp, PacWest, Comerica, and Charles Schwab. Signature Bank was quickly seized by the regulators (FDIC). USDC was depegged from the USD as well, worsening the solvency of the two banks. It became clear that we still haven’t learnt from the 2008 financial crisis.
One of the events that prompted the 2008 financial crisis was the contagion effect. One bad fruit made the entire fruit basket stale. Fractional reserve banking meant that bankers could take on more risks with people’s money at no cost. Today, with the growing popularity of cryptocurrency, the fractional reserve banking is still being used, which makes a bank run more lethal than it should have been.
Silvergate and Signature Bank were the two Bitcoin friendly banks supporting the fiat payments for Bitcoin payments in the US through the Silvergate Exchange Network (SEN) and Signature’s Signet. Coinbase and other crypto trading firms relied on these two banks for their real time payments. Since the collapse of the 2 banks, the financial industry was left in limbo.
50% of venture-backed companies in the US had their money in SVB.
SVB’s deposits soared from $100 Bn in 2020 to $189 Bn in 2021.
Since not many people took loans from SVB, they decided to invest in Mortgage Backed Securities. It was wrong to invest short term funds in long term volatile assets, because it puts the bank at risk of a bank run when depositors ask for their money back.
The declining stock market performance resulted in SBV’s share price decline by 66%, while rising interest rates (by the Fed) made SBV’s cost of capital (customer’s deposits) more expensive. Additionally, SBV invested half of customer’s deposits (short term funds) in treasury bonds (long term investment), and the Fed’s rising the interest rates caught them unawares. To cover the shortfall, they tried to raise $3bn of equity, and when that failed, a bank run ensued.
SVB’s failure occurred because a small but wealthy group of depositors decided to withdraw their funds, and at the same time startups faced a funding crunch (VCs stopped funding early stage firms and focused on later stage firms) which forced them to rely on bank deposits to meet administrative expenses.
Incidentally, the management at SVB paid themselves bonuses days before sinking the ship. So far, they are yet to be charged.
Again, those who fail to learn from history are doomed to repeat it. The 2008 financial crisis showed that the financial system is corrupt and flawed, and their systems unreliable. Banks are overleveraged, opaque and interdependent.
The people who will lose are the depositors who had their uninsured funds in the two banks, and the startups who use the banks for payroll and other administrative expenses. There is also the risk that the regulator may not have all the funds necessary to refund all the depositors for the full insured amount ($250,000).
Why should you be aware? Because every time you trust a banker with your money, you take on that bank’s solvency risks but also all the 3rd parties on which the bank depends on. Protecting yourself from a counterparty risk (for example, a bank run) is a wise decision, and it is necessary to protect and grow your wealth.
This is why we are on a mission to promote financial literacy, because ignorance isn’t always bliss. You deserve to be aware and ready, and have all the tools to protect your wealth from others. You can’t rely on the government, who steals your wealth by printing money and inflation. You can’t trust the bankers either, because they have shown they can be terrible stewards of people’s deposits.
A bank run is one of the events that demonstrate what a crisis of confidence can do. The financial system needs to repair its battered image, and one way to correct that is to abolish fractional reserve banking.
One thought on “SVB’s Collapse: One Bad Maize Spoils the Harvest – Why Contagion is Bad for Everyone”
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