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SVB: So Many Reasons To Fail
The failure of Silicon Valley Bank is making national news, and is being talked about as a big surprise. But it was inevitable and might just be the canary in the coal mine. Some causes of the failure include:
Federal Reserve purchasing trillions of dollars of government debt and paying for it with nearly $9 trillion in newly created liabilities that ballooned bank liquidity.
Federal Reserve holding interest rates near zero, with statements that it would keep them at that level indefinitely, and encouraging banks and business to engage in speculative activities to boost the economy.
SVB accepting a high concentration of uninsured deposits from venture and equity funds while the regulatory authorities watched.
SVB choosing to grow its assets by an average of 67% per year for three years; purchasing credit-risk-free, longer term, low yielding government or government guaranteed securities, while accepting significant duration risk by assuming the Federal Reserve would keep interest rates low. This led to reported unrealized losses in the securities portfolio that essentially wiped out its available capital.
Regulators allowing SVB to systematically increase its risk profile, judging it as adequately capitalized with a risk-rated Tier I capital ratio of 16%, when the capital-to-assets ratio was less than 8%, and the tangible capital-to-asset ratio was near 5%. In contrast, requiring SVB to fund itself and maintain a capital-to-asset ratio closer to 15%, likely would have slowed its 67% average annual growth rate and reduced its probability of failure.
As the Federal Reserve continues to fight inflation and raise interest rates, SVB should be a wakeup call to the industry and its regulators to plan for more of these kinds of events. The banking industry has well over $600 billion of unrealized losses hanging over it and as rates continue to rise, the value of other assets will come under downward pressure. SVB is a warning to each of these groups that the fight against inflation will be costly, and how to handle future losses and volatility should be priority number one.
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