Silicon Valley Bank crisis and personal finance learning

The Silicon Valley Bank crisis generated a lot of commotion. I’m not a professional, to analyze the bank’s failure. Nonetheless, there are lessons in personal finance to be learned from all of these financial catastrophes.

Silicon Valley Bank crisis

As I’ve already stated, I lack the expertise to write a thorough post about the Silicon Valley Bank crisis or express my opinions. Yet as a human, I can understand to some level by reading.

Silicon Valley Bank crisis explained

Let me first explain in a simple way how this crisis unfolded.

# SVB was founded in 1983 and was the 16th largest U.S. bank before its collapse.

# SVB is specialized in banking and finance startups and most tech companies.

# SVB was a preferred bank for these start-ups because bank-supported startup companies that not all banks would accept due to higher risks.

# Banks get the money in the form of current account balances, savings account balances, fixed deposits, or recurring deposits.

# As they promised you to pay certain interest (excluding current account), they have to invest or lend this money somewhere to give back to you the promised interest and principal safely.

# Assume that FDs are at 8%, then banks have to invest or lend to someone where they have earning possibility of more than 8%.

# During the Covid period, due to IT booming as consumers started spending on digital services and electronics, these tech start-ups started to get a lot of cash.

# As SVB was a preferred choice for all these startups, the majority of these startups parked their money with this bank. Between the end of 2019 and the first quarter of 2022, the bank’s deposit balances more than tripled to $198 billion. However, during this period, the industry’s deposit rate was around 37%.

# However, there were no borrower’s percentage declined drastically during this period.

# Because of this, as banks can’t keep the depositor’s money idle, around 15% was lent, and the rest 85% was invested in securities portfolios or kept as cash. Around two-thirds of the deposits were non-interest-bearing demand deposits and the rest offered a small rate of interest. The deposit rates were around 1.17%.

# Bank invested this money in something called AFS (Available For Sale) securities and HTM (Hold To Maturity) securities. AFS securities mean holders can sell the securities before maturity. However, the price of selling depends on at what rate the bond is trading. However, in the case of HTM, you are intended to hold till maturity. Hence, you no need to bother about the volatility of the price in a secondary market. But as you can’t sell before maturity, your money is locked.

# It adopted two types of investment strategy: to shelter some of its liquidity in shorter duration available-for-sale (AFS) securities while reaching for yield with a longer duration held-to-maturity (HTM).  

# Now the real issue started. As inflation increased drastically in the USA and in fact across the globe, the interest started to increase. Because of this, bond prices turned negative and especially long-term bonds.

# Without diversifying the portfolio, without analyzing the immediate short-term requirements of the bank, SVB invested moved money to long-term securities. Due to this, the unrealized losses increased drastically, from nothing in June 2021 to $16 billion by September 2022. The smaller AFS book was also impacted, but not as badly. 

# This fall in value was so much so that Silicon Valley Bank was technically insolvent at the end of September.

# To fund this or not sure, when SVB announced their $1.75 billion capital raising on March 6, people became alarmed that the bank was short on capital. Word spread, and customers started to withdraw money in waves.

# If the bank has to fund the depositors, then it has to sell the securities in the secondary market at a discounted price. As the price fell drastically due to inflation and the interest rate cycle, the loss was huge to compensate for the bank.

# California regulators finally shut the bank down on March 8 and placed SVB under the FDIC.

This is the story that I have understood with my limited capacity and knowledge. However, I may be wrong, and correct me if I am wrong in my knowledge. Because the purpose of this post is to what we can learn from such bank failures to our money than digging deep and doing research about why the failure of SVB.

Silicon Valley Bank crisis and personal finance learning

# Banks are run by humans

You must acknowledge that banks are managed by humans and that it is extremely likely that mistakes will be made. Reasons for failure may differ. However, we can’t avoid the crisis completely. There have been a lot of these banking collapses throughout history, and there may be a few more in the future. Hence, regardless of the restrictions in place, we have to be prepared to experience such banking failures.

# Your Deposits are unsafe

Deposits up to Rs. 5 lacks are the only ones that, according to Indian banking, are insured. In addition, it is not. So, you must first comprehend this fundamental concept. Nonetheless, parking in a Post Office is the finest option if you’re seeking a completely safe feature for your FDs or RDs because Post Office products have sovereign guarantees.

# Diversification is a mantra

The primary reason for SVB’s downfall was its greater exposure to one class of assets. This resulted in a complete mess in handling a diversified investment or lending strategy. To reduce the chance of failure, we as individuals must always diversify our investments. If you have a sizable amount of money to deposit, spread it out among family members or across many banks.

Concentrated investment is always risky.

# Risk can’t be avoided

No matter what type of investment we make like FDs, Debt Funds, Bonds, or stocks, we cannot entirely eliminate risk. As a result, the only path ahead for all of us is to manage risk rather than avoid it.

In fact, keeping money in your savings account or in cash mode in your home is also risky (of which many are unaware).

# Debt investment does not mean it is safe

We have a mindset to assume that equity is risky but debt is not. Looking at the current situation of SVB, you will find that debt also you have risks like default risk, credit downgrade risk, interest rate risk or reinvestment risk.
Hence, never ever assume that a debt portfolio is safe. If you don’t know what you are doing, then even a debt portfolio may also pose a huge risk.

# Choosing the right debt instrument

All debt products are not the same. They carry different risks. Hence, understanding the risk is very much important. Take for example, by investing in Government bonds or Gilt Funds, you may completely avoid the default or credit downgrade risk. However, you can’t run away from interest rate risks. Hence, choosing the risk product based on your requirement is best rather than blind investing.

# Never chase the returns from debt

Investors chase the yield in the debt portfolio also. The classic example is Franklin’s fiasco. However, this leads to huge risks. If you are really interested to take risks, then increasing your equity allocation is far better than investing in a low-rated and high-yielding debt portfolio.

Conclusion – The Silicon Valley Bank crisis is more of an American one, but bad news about it could have global repercussions. Its impact on Indian banks may be NIL. Yet, a global panic situation might develop. Like Yes Bank, PMC Bank, or other cooperative banks, we have also experienced banking failures. The causes could vary. Additionally, the RBI’s stringent rules may prevent a major banking crisis from happening. But we also need to prepare mentally.

6 thoughts on “Silicon Valley Bank crisis and personal finance learning”

  1. All the points mentioned in the learning are important.
    But few points to remember are that, Debt instruments are not safe, as they have both Interest Rate Risk and Defaulting risk.
    Some of the large banks and Insurance companies in India invest their depositor’s money carelessly in stocks at abnormally high valuations and lend money to poorly governed private companies, and those are at the highest risk of failing. There have been ample cases in the past and there will be in future.
    An investor should always look for large safe banks with very low Non Performing Assets where they should park majority of their funds and restrict funds in other banks to some limit.
    Also, an investor should invest only in Liquid Funds and Money market funds to avoid interest rate risk to large extent or post office schemes which has sovereign guarantee.
    Most of us have learnt these lessons in the past few years and SVB bank collapse teaches us these lessons again.

  2. Thank you very much for the insights sir,
    As you said debt investment also carries risk.

    Kindly give us some insights about equity saving funds , which invests in equity as well debt
    Regards
    SIVASRI

  3. Quite nicely summarized the whole episode of SVB failure. My take on this:
    1. There was a “asset-liability” mismatch in terms of :
    – Duration of instruments on both sides : means that your asset maturity ‘duration-wise’ has to “match” with liability duration, otherwise, there will be severe mismatch.
    – Ideally there should be a “margin-match” also on both the sides of your balance sheet : means that your liability side interest obligation should, at the minimum, “match” with asset side interest earning capability. Or to put it simply, NIM at all the sub-sets of liability should match/higher with asset side.
    2. All banks should be extremely careful about this asset-liability match planning during interest up cycle because of rising yield and falling NAVs.

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