Bank failure is something we have not seen for a very long time since the Great Depression. Prior to the Great Depression, bank failure was a common thing. It was, in fact, the source of many economic and financial crises in the United States. The Panic of 1907, for example, was the result of bank runs. A bank run occurs when many clients withdraw their money from a bank because they believe the bank may cease to function in the future. Bank runs have a domino effect. When one bank fails and depositors hear about the failure of that bank, they immediately rush to their respective banks to withdraw their money under the fear that their bank may become insolvent, which then causes, in turn, these banks to become insolvent and therefore fail because they do not have enough money to pay back all of their depositors. This was common practice prior to the Great Depression.
To avoid having a bank run, the federal government established the FDIC (Federal Deposit Insurance Corporation) through the Banking Act of 1933, whose role was to prevent bank runs. The FDIC insurance deposits in member banks up to $250,000 per ownership category and its insurance is backed by the full faith and credit of the U.S. government. Today, the unexpected happened. The Silicon Valley Bank, known by its initials as SVB, which is an FDIC-insured bank, failed. And the failure of this bank has dropped the stock market, today, to significant lows. The SVB stock plunged 87%. How is this possible? What has happened? What led to the collapse of this bank? Why did the FDIC not do anything to prevent it?
SVB tried to raise capital but ultimately failed. As of the end of December 2022, SVB had roughly $209 billion in total assets and $175.4 billion in total deposits. SVB was a major bank for venture-backed companies, which were already under pressure due to higher interest rates and a slowdown for initial public offerings that it made more difficult to raise additional cash. The failure to raise capital generated a general panic among investors. Indeed, on March 8, SVB announced that it had taken a $1.8 billion loss from selling assets—$21 billion of relatively low-yielding treasury securities, and SVB also borrowed $15 billion; and organized an emergency sale of its stock to raise cash. Thus, investors feared that SVB wouldn’t have sufficient capital to cover its positions. Some venture capital firms, such as Peter Thiel’s Founder Fund, have encouraged their portfolio companies to move their money out of SVB due to concerns about its financial stability. As a result, the failure of SVB is affecting the banking sector, and the fall of the banking sector is dragging down the stock market.
The failure of SVB prompted regulators to step in. Regulators closed troubled SVB after deposit outflows and a failed capital raise plunged the country’s 16th largest bank into crisis. As we know, the FDIC’s standard insurance covers up to $250,000 per depositor, per bank, for each account ownership category. It is unclear, however, how larger accounts or credit lines for companies will be impacted by the closure. The FDIC said it will pay uninsured depositors an advanced dividend within the next week.