Banking regulators in California Friday closed the Santa Clara-based Silicon Valley Bank (SVB), the 16th largest bank in the US until 2022-end, after its collapse as depositors started to withdraw their money earlier this week amid news of the bank’s poor financial health. The bank’s depositors were mainly workers in the technology sector and companies running on venture capital. What the SVB experienced is considered one of the oldest problems in the banking sector — a bank run.
What Is A Bank Run?
The dictionary meaning of a ‘bank run’ is the time when a large number of people simultaneously take out their money deposited with a bank or any other financial institution over fears that it could go out of business.
History is replete with instances of bank runs over concerns of solvency. In fact, it was in response to a bank run that the Federal Deposit Insurance Corporation (FDIC), which has been appointed as the receiver for the eventual disposition of SVB’s assets, was established in the year 1933. “In the 1920s and early 1930s, a rise in bank failures created a national crisis, wiping out many Americans’ savings,” the FDIC says on its website, adding: “Since FDIC insurance began in 1934, no depositor has lost a single penny of insured funds due to bank failure.”
With FDIC, depositors are insured to at least $250,000 per banking institution.
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History of Bank Runs
The decade of the Great Depression, starting in 1929 and lasting until 1939, saw several instances of bank runs as countries across the world witnessed a major economic downturn.
A bank in Tennessee was the first to fail in the US due to mass withdrawals in 1930, following the 1929 stock market crash. Among the next was the Bank of United States. Bank runs became the norm as the failure of one bank put fears in the minds of people who had accounts in other banks, leading to mass withdrawals from those banks.
The FDIC came into being as the US administration, under President Franklin D Roosevelt, took several steps to prevent a recurrence of such a crisis.
Several countries in Europe — Austria’s Credit-Anstalt and Germany’s Danatbank for example — too experienced bank runs during the Great Depression.
The last time the US saw a banking crisis of the SVB magnitude was in 2008 when Washington Mutual collapsed, leaving the economy in doldrums for years. The 2008-09 crisis led to regulators in the US and other countries forming tougher rules to ensure that the failure of a particular bank does not harm the economy on a wider scale.
In 2012, Greece and some other countries in Europe also witnessed bank runs, albeit on a smaller scale.
A bank run typically happens as a result of panic, irrespective of the fact whether the bank in question will actually face insolvency or not. However, as customers keep withdrawing their money, it eventually does lead to a default situation for the bank.
“Fear is contagious,” says Angela Lee, a professor of venture capitalism at the Columbia Business School. “Bank runs can start on a rumor and this is much bigger than a rumor. I worry about folks overreacting to this and overcorrecting,” she tells The Guardian while talking about the SVB collapse fallout as global financial institutions are on alert amid concerns that the crisis could put the customers’ savings at risk.
What Led To Bank Run At SVB?
There are several factors that contributed to the collapse of Silicon Valley Bank, starting from the Federal Reserve raising interest rates to some clients of the bank facing cash crunch to the bank selling a bond portfolio at a loss, as reported by news agency Reuters.
According to the report, the higher interest rates made investors averse to risk as their money became expensive. What compounded the situation was the liquidity crunch faced by startups, the main clients of SVB, as the higher interest rates caused the IPO market to shut down and private fundraising became costlier, leading to the companies to start taking out their money from the bank.
To salvage the situation, the report said, SVB sold a bond portfolio of $21 billion, which consisted mostly of US Treasuries, at a loss of $1.8 billion.
What also hit the SVB hard was a downturn in the technology stocks it had invested in over the past year, according to a report in Associated Press. The bank had bought bonds worth billions of dollars, but their value fell in the current environment of higher interest rate, the report said.
While this isn’t an issue usually because banks typically use consumers’ money for their investments that they can hold onto for a long time, the crisis happened because SBV consumers are mainly startups that had been facing cash crunch with venture capital funding drying up and they started to withdraw the money parked in the bank causing the bank run, the AP report explained.