Notwithstanding their concerns following the failure of a California-based lender, economists believe that a crisis similar to the one that occurred with Lehman Brothers is unlikely.
Silicon Valley Bank's (SVB) demise has shocked the financial and technological communities.
The Santa Clara, California-based bank's assets were seized by US regulators on Friday after customers started withdrawing money in large amounts due to concerns about the lender's financial stability.
Financial regulators from all over the world have now hurried to stop the effects of SVB's collapse, the biggest bank failure in the US since 2008, and restore trust in the global financial system.
What caused SVB to fail?
The bank's business was largely centered on US technology companies, as its name suggests. The banking experienced a spike in deposits during the COVID-19 pandemic as tech businesses made money by offering entertainment and delivery services to those who were confined to their homes.
One of the safest sorts of investments, US government bonds were where SVB put a large portion of this money to work.
The US Federal Reserve started boosting interest rates last year in reaction to soaring inflation, which led to a decline in the value of those bonds and the start of SVB's problems.
During the pandemic boom, the tech industry's financial situation became increasingly precarious, and many of SVB's clients started using their funds to stay afloat. Concerns regarding SVB's financial stability arose when it was forced to sell its bonds at significant losses due to a lack of cash.
Depositors who were alarmed withdrew enough money within 48 hours to bring about the bank's demise.
"SVB failed as a result of their interest-rate-risk management team's foolish rookie error: they put short-term deposits into long-term bonds. "The value of the bonds decreased as interest rates rose, erasing the bank's equity," James Angel, a Georgetown University expert on international financial market regulation, told Al Jazeera.
The US Savings and Loan business was completely destroyed by this occurrence in the 1980s. Some individuals never learn.
Campbell R Harvey, a professor at Duke University's Fuqua School of Management, said that SVB's difficulties were a lesson in the need for banks to diversify their holdings.
We all know that the technology industry has suffered, and if you aren't diverse, you will suffer as well, Harvey told Al Jazeera. "It does seem like it caters to a particular audience," Harvey said.
Harvey continued, "Your loan book needs to be diversified. "It's not immediately clear that this bank did this,"
What effects has SVB's demise had thus far?
The assets of New York-based Signature Bank, a lender known for its work in the cryptocurrency industry, were seized by US regulators two days after SVB's demise, making it the third-largest bank failure in US history.
US regulators declared on Sunday that they will guarantee all deposits at both firms in an effort to contain the consequences.
The Bank Term Financing Program (BTFP), a new lending initiative from the Federal Reserve, intends to increase banks' confidence in the financial system by allowing them to borrow money directly from the Fed rather than having to rely on losing bond sales.
In an effort to reassure the public that the crisis is under control, US President Joe Biden stated that "Americans can have faith that the banking system is safe."
But, with worries about a ripple effect throughout the financial industry, bank shares, especially those of the US "big four" - JPMorgan Chase, Bank of America, Wells Fargo, and Citibank — have fallen substantially.
The stock price of San Francisco, California-based First Republic Bank, a mid-tier financial institution, fell as much as 60%.
Additionally, bank shares in Europe and Asia have decreased significantly.
In order to protect 6.7 billion pounds ($8.1 billion) in deposits, regulatory regulators in the United Kingdom announced they had facilitated the sale of SVB's local arm to HSBC, Europe's largest bank.
German officials said they had temporarily closed the local branch of the institution, while Canadian regulators declared they had temporarily taken control of the nation's SVB business.
How significant a player in the banking sector was SVB?
The 16th-largest bank in the US at the time was SVB, which has been referred to as a mid-tier institution rather than a big participant.
Although it is a substantial bank, it is uncommon in that Harvey described it as such.
According to the Federal Deposit Insurance Corporation, the lender has $175.4 billion in total deposits as of December and $209.0 billion in assets.
The largest bank in the US, JPMorgan Chase, had assets of $3.67 trillion last year.
SVB, however, had a significant impact on the tech industry. The lender had a good reputation for supporting startups that larger banks would have deemed to be too risky to lend to and was well-connected among the Silicon Valley elite.
After SVB's failure, some IT chief executives reportedly rushed to switch banks and looked into other options for paying personnel out of concern that they wouldn't have access to their money.
Although the deposits of SVB's customers were finally insured, the full impact of the lender's collapse on the startup sector would not be felt for some time.
Might SVB's demise lead to a financial crisis similar to that of 2007–2008?
Although the effects of SVB's bankruptcy are still being felt, economists generally concur that it differs noticeably from the collapse of financial giants like Bear Stearns and Lehman Brothers that sparked the global financial crisis in 2007-2008.
SVB's business was mostly focused on one industry and interacted with other banks not nearly as frequently as organizations like Lehman Brothers.
David Skeel, a professor of corporate law at the University of Pennsylvania Law School, told Al Jazeera that although the SVB situation "certainly has people worried, I don't think it's likely to turn into a Lehman type of situation." This is especially true given how aggressively the Fed has intervened, including by promising to protect even uninsured deposits.
“I think any direct fallout is likely to become clear pretty quickly, although it’s certainly possible that there are other banks that are in a similar predicament due to the rise in interest rates.”
With the 2007–2008 crisis, financial regulation has also been severely tightened.
“Fortunately, the increased capital requirements imposed after the 2008 crisis seem to be paying off,” Angel said.
“Banks are now required to have much more capital than before, making them much less risky. Even the banks that have made stupid mistakes mostly lose their own money and not that of depositors.”
Texas State University associate professor of finance and economics William T. Chittenden expressed his optimism that the spread of SVB will be minimal.
“With the BTFP, banks will be able to borrow against those securities at par value, allowing banks to avoid selling them at a loss. This should give banks the liquidity they need to meet any unexpected demand for cash from their depositors,” Chittenden told Al Jazeera.
“We will know if this is working or if there is wide-spread fallout from SVB’s failure in the next few days,” he added. “The vast majority of banks in the US are financially sound and with the new BTFP, depositors should feel at ease.”
(AL JAZEERA)