On March 11, 2023, Silicon Valley Bank (SVB), a leader in the American banking industry with over $200 billion in assets, announced its bankruptcy without warningThis monumental event has shocked many, marking it as another colossal downfall for the banking sector since the 2008 financial crisisWhat is particularly astonishing is that the entire chain of collapse unfolded within just 48 hours, from the first signs of trouble to total failure.

The repercussions of this bankruptcy quickly rippled through various sectors, impacting the U.Sstock market, the banking industry, as well as markets in Europe and Asia, and even extending to the cryptocurrency worldSo, what truly happened? Why did this bank collapse so suddenly? And what implications does this hold for the average person? Let us explore the intricacies behind this shocking collapse.

To understand the downfall of SVB, we need to rewind back to the beginning of 2020 when the COVID-19 pandemic struck like an unstoppable storm, sending the global economy into a downward spiral

On March 3, 2020, in a bid to inject some life into the ailing economy, the Federal Reserve announced an emergency interest rate cut of 0.5%. Just twelve days later, on March 15, the Fed made a bold move by cutting the interest rate to between 0% and 0.25%, effectively unleashing a flood of monetary stimulus on an unprecedented scale.

This series of aggressive rate cuts was, however, tightly interwoven with the fate of Silicon Valley BankDuring this period, the bank saw an influx of nearly cost-free deposits, elevating its total deposits from $76 billion in mid-2020 to over $190 billion by the end of 2021. While these deposits represented a treasure trove for customers, from the bank's perspective, they were liabilities—low-cost liabilities that required near-zero interest payments.

With such a colossal amount of low-cost funds at its disposal, SVB sought avenues for investment

• Divergence in Monetary Policies: U.S. and Japan
• LPR Holds Steady
• Impact of Japan's Exit from Ultra-Loose Monetary Policy
• U.S. Stock Index Futures All Rise
• Fed Rate Cuts Won't Heal Europe's Economic Wounds

Notably, despite its Silicon Valley identity, the bank initially did direct funds to local startups, but the anticipated loan demand from these entrepreneurs did not materializeInstead of skyrocketing, it actually began to decline.

Consequently, SVB pivoted to invest heavily in low-risk Treasury bonds with maturities ranging from one to five yearsThe prospect of these bonds might feel secure, yet they offered only 1% annual yield, which, while cost-effective, was barely enough to generate a meaningful profit.

Yet, lurking within this seemingly safe investment strategy was a crucial riskMost of these bonds were intended to be held to maturity, meaning that the bank could only recoup its principal and interest upon expiration of the bondsIf SVB needed to sell these bonds earlier, it would incur significant losses due to the market valuation of the bonds dropping.

This situation gave rise to the concept of "long-term holding of short-term debt," suggesting a mismatch between liquid deposits and long-term investments

For instance, demand deposit accounts allow customers to withdraw funds at any moment, while a five-year Treasury bond locks away that money for the duration of its termTheoretically, in a worst-case scenario, all depositors could demand their savings simultaneously, while the bank would find it impossible to call back its loans.

To mitigate this maturity mismatch, banks operate on a deposit reserve requirement systemOne may ponder: just how much cash should a bank reserve to handle unexpected withdrawal demands from customers? In theory, the occurrence of all depositors demanding their savings at the same time is extremely lowTherefore, as long as the bank retains a certain percentage of cash on hand, it can typically satisfy the vast majority of withdrawal requestsThis is why most countries have established deposit reserve requirements to ensure bank stability.

In China, for instance, the reserve requirement ratio hovers around 7.8%; meanwhile, the United States even lowered it to 0% to stimulate the economy during times of crisis.

However, one may wonder, what happens to our savings if a bank goes under? Banks are not infallible structures that never collapse

In China, for instance, individual deposits under 500,000 yuan are insured, ensuring that depositors are compensated should the bank failAs a result, many individuals opt to "diversify their risk," spreading their funds across several banks and keeping deposits under the insurance cap to feel more secure.

However, for large corporate deposits, this strategy proves impracticalThe savings insurance limit in the U.Sis set at $250,000, and an alarming 90% of SVB's deposits exceeded this capThis left a vast majority of depositors exposed, and in the event of a crisis, they could face significant losses, hopelessly hoping for the worst not to occur.

As fate would have it, beginning in 2022, the Federal Reserve entered a cycle of consecutive interest rate hikes, with rates reaching between 4.5% and 4.75% by February 2023. Meanwhile, SVB's Treasury bonds, yielding only 1%, meant that the institution was bleeding money as borrowing costs surged above 4%. Essentially, the bank was operating at a net loss, but these losses remained unseen until the bonds matured in the future.

To exacerbate matters, the tech industry in the United States began to face headwinds, contracting as major players like Tesla, Facebook, Microsoft, and Twitter instituted layoffs beginning in the latter half of 2022. This contraction in the tech sector led to a broader retrenchment in budget allocations, hiring freezes, and a bleak outlook from venture capital firms, with many urging startups to tighten their belts.

SVB's core clientele was predominantly tech companies, and as the fundraising environment tightened, these entities turned to their bank to withdraw funds more frequently to keep operations afloat

This unprecedented withdrawal left SVB grappling with intense liquidity issues.

In an effort to cover cash shortfalls, the bank began selling off assets, primarily its long-term Treasury bondsHowever, selling these bonds before maturity resulted in considerable lossesWhen SVB offloaded $21 billion in securities, it experienced an immediate loss of $1.8 billionThis alarming news triggered panic in the market.

On March 8, applications for withdrawals and fund transfers skyrocketed, exceeding $42 billionStartups and investment firms, seeing the chaos, initiated a frantic exodusWith only $10 billion in liquid assets at its disposal, SVB was utterly unable to withstand such a tremendous wave of withdrawals and eventually, the unthinkable happened: it declared bankruptcy.

The CEO of Y Combinator, a prominent startup accelerator, lamented that the implications of this event were catastrophic for startups dependent on SVB

With a significant amount of capital tied up in the bank, an inability to recover these funds could end the lifeline for numerous budding enterprises, potentially erasing them from the market.

Following the collapse, 125 venture capital firms, including esteemed institution Sequoia, rapidly united to urge government interventionThey also expressed willingness to collaborate with anyone acquiring SVB, emphasizing the dire need for a solution to mitigate the fallout from this disaster.

Elon Musk also shared his perspective via Twitter, admitting the uncertainty of future outcomes and adopting a wait-and-see approach in this chaotic environment.

This unfortunate incident acts as a stark reminder of the extensive risks associated with mismatched maturity structures and the myriad dangers of "long-term holding of short-term debt." It is crucial not to wait for a catastrophic collapse to comprehend the soundness of financial strategies