Silicon Valley Bank's Investment in Long-Dated Bonds Causes Collapse

Silicon Valley Bank (SVB), the preferred bank for the tech sector, collapsed suddenly after a series of unfortunate investment decisions. The California-headquartered organization grew to become the 16th largest bank in the US, catering to the financial needs of technology companies worldwide before its collapse.

SVB’s services were in hot demand throughout the pandemic years. The initial market shock of Covid-19 in early 2020 quickly gave way to a golden period for startups and established tech companies, as consumers spent big on gadgets and digital services. Many tech companies used SVB to hold the cash they used for payroll and other business expenses, leading to an influx of deposits.

The seeds of its demise were sown when it invested heavily in long-dated US government bonds, including those backed by mortgages, which were considered as safe as houses. However, bonds have an inverse relationship with interest rates, and when rates rise, bond prices fall. When the Federal Reserve started to rapidly hike rates to combat inflation, SVB’s bond portfolio lost significant value.

If SVB were able to hold those bonds for a number of years until they mature, then it would receive its capital back. However, as economic conditions soured over the last year, with tech companies particularly affected, many of the bank’s customers started drawing on their deposits. SVB didn’t have enough cash on hand, and so it started selling some of its bonds at steep losses, spooking investors and customers. It took just 48 hours between the time it disclosed that it had sold the assets and its collapse.

SVB’s collapse has raised concerns about a potential banking crisis, with immediate concerns of widespread contagion having been contained by the US government’s quick response in guaranteeing all deposits of the bank's customers. Financial futures, which allow investors to speculate on future price movements, rallied for the US technology sector in response to the guarantees.

There are also concerns about whether SVB’s vulnerability to rising interest rates is paralleled in other banks through an over-exposure to falling bond prices. To counter the risk, the Federal Reserve has unveiled a new program that allows banks to borrow funds backed by government securities to meet demands from deposit customers.

This is designed to prevent banks from being forced to sell government bonds that have been losing value due to rising rates. The Fed's financing will be made available through the creation of a new Bank Term Funding Program (BTFP), offering loans of up to one year to banks, savings associations, and credit unions pledging U.S. Treasuries, agency debt and mortgage-backed securities, and other qualifying assets as collateral.

SVB’s collapse has dealt a significant blow to the tech industry, which has been cutting staff as economic conditions deteriorate. At a time they need financial backing, one of its biggest supporters has collapsed. The longer-term question is whether SVB’s problems are indicative of broader weakness in corporate balance sheets caused by rising rates.