Silicon Valley’s primary technology lender rapidly crashed over the span of fewer than forty-eight hours this past week. Although a variety of factors contributed to the downfall of the bank, the root cause lies in the bearish trends the tech sector has been facing as a whole since the beginning of 2022.
The volatility of the technology industry is unquestionable and has risen since the coronavirus pandemic began. The tech-heavy NASDAQ Composite gained over 130% from the period the coronavirus began to the end of 2021. After the Federal Reserve announced a series of interest rate hikes and a generally stringent supply chain, the entire stock market, spearheaded by big technology corporations slid over 30%, numbers seldom seen since the 2001 dotcom bubble.
In the midst of the elongated market decline, growing numbers of businesses began to cut budgets and withdraw from banks to account for payroll and inflation-exacerbated expenses. The general downturn the market faced, especially for Silicon Valley startups, resulted in the various securities held by SVB declining in value sharply. However, the tech financier was forced to sell them to finance the withdrawals various businesses were making.
A bank operates by facilitating the circulation of money within the economy. Entities store their savings in a bank which provides them with a secure location as well as recurring interest payments. With the capital received, the bank loans the money to other individuals at a higher interest rate which is used to finance various expenditures. As borrowers take out loans, the currency is often not immediately expended and large portions of it often remain with the bank. Thus, the bank is free to use this capital to loan to other borrowers. Thus, the same amount of money loaned from individuals with bank accounts will multiply many times for borrowers to borrow.
With this relatively stable business model, banks are among the most stable corporate institutions in the world. Nevertheless, blatant issues arise when significant amounts of lenders attempt to withdraw from their bank accounts simultaneously. There exists a certain point in which the bank does not possess the amount of liquidated capital needed to pay back its lenders. In these common scenarios, banks must borrow money from other banks in order to repay its own creditors. Once the banks no longer possess adequate funding to continue, it must borrow from the Federal Reserve.
The reason why the Federal Reserve is so important in the American monetary system is because the quasi-Central Bank system determines the interest at which it loans money to banks. Lower Federal Reserve interest rates result in lower interest rates from and between the banks, which induces more borrowing. The converse is true for higher interest rates.
Due to recent market movements, including efforts by technology companies balance their finance sheet, withdrawals from the Silicon Valley Bank have significantly increased recently. In an attempt to balance their own balance sheets amid mass withdrawals, SVB announced on Wednesday that it would sell $2.25 billion in new shares to accommodate for its securities losses. The announcement triggered pandemonium among many prominent venture capitalists who urged the startups they were backing to leave the bank for fear that it may crash. Venture capitalists are investors to invest in risky startups hoping for high return. The warning expectedly fulfilled itself when startups withdrew capital from the bank in haste in hopes to do so before the bank crashed. Inevitably, the bank run crashed when Federal Deposite Insurance Corporation regulators closed the bank.