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The collapse of Silicon Valley Bank

Silicon Valley Bank‘s sudden collapse in recent days has sent shockwaves through the tech industry and financial markets alike. The lender, which provided funding to many of the biggest names in tech, was caught off-guard by rising interest rates and its unique structure, which included a significant number of uninsured depositors. The bank’s need for fresh capital to shore up its balance sheet ultimately proved too great, as startup clients withdrew deposits to keep their companies afloat.

The downward spiral began when the bank surprised investors with the news that it needed to raise $2.25 billion. This sparked a bank run on Thursday as venture capitalists instructed their portfolio companies to move funds, concerned about the existential threat posed by the inability to tap their deposits. The highly interconnected nature of the tech investing community contributed to the bank’s sudden demise, with concerns that startups may be unable to pay employees in the coming days and venture investors may struggle to raise funds.

SVB’s failure highlights the far-reaching ramifications of the Federal Reserve’s most aggressive rate-hiking campaign in four decades. The tech sector, which was already struggling, could now face an even deeper malaise. The recent tumble in SVB Financial Group’s shares has led to a rush to defensive options on bank stocks, with traders piling into defensive bets in financials such as UBS Group, Bank of New York Mellon, and Charles Schwab.

Traders are wary that they could signal broader issues in the sector as the Federal Reserve’s campaign to fight inflation exposes vulnerabilities in the market. Investors have re-rated banks on a sectoral basis and initiated a flight into the safety of short-term Treasury notes. The situation serves as a reminder of the effects of rising rates and an inverted yield curve on the financial sector.

Silvergate Liquidation
Silvergate Bank, a cryptocurrency-focused lender based in California, has announced its intention to wind down operations following a significant loss of customer deposits. The bank was hit hard by the collapse of cryptocurrency exchange FTX, with investors withdrawing over $8 billion in deposits and causing the bank to incur losses as it sold assets to cover the cost of withdrawals.

Last week, Silvergate warned that it was “less than well capitalised” and was evaluating its ability to operate as a going concern. The bank has now decided that a voluntary liquidation is “the best path forward” in light of recent industry and regulatory developments.

The wind-down and liquidation plan will include full repayment of deposits, according to Silvergate. The bank reported a $1 billion loss for the fourth quarter of 2022, and multiple partners, including Coinbase and Galaxy Digital, cut their links with Silvergate last week. 

Coinbase has since confirmed that it had no client or corporate cash at the lender, while Binance CEO Changpeng Zhao said his company did not have any asset losses at Silvergate.

Silvergate, which ventured into crypto in 2013, had also operated a mortgage warehouse business but announced in December that it would be winding down that division due to the rising interest rate environment and reduction in mortgage volumes. Last week, the bank also discontinued the Silvergate Exchange Network (SEN), its crypto payments platform and one of its most popular offerings. The network allowed for round-the-clock transfers between investors and crypto exchanges, unlike traditional bank wires, which can take days to settle.

Although risks of contagion are minimal, given that Silvergate has said it will repay depositors and has performing loans, the loss of SEN is disappointing, said Ram Ahluwalia, the CEO of Lumida Wealth, an investment adviser that specialises in digital assets.

Mitigating Risks
Recent events have sparked concerns about the stability of the banking sector, particularly following the collapse of Silicon Valley Bank and the near-collapse of Signature Bank. However, the US government has taken swift action to guarantee customer deposits and assure the public that their banking system is secure.

To further mitigate risks and safeguard the financial sector, the Federal Home Loan Bank system has taken steps to raise tens of billions of dollars through the sale of short-term notes. This move underscores the growing concerns within the financial sector and the need to fortify balance sheets against deposit flight.

The FHLB’s crucial role as a lender of second-to-last resort has been highlighted in its ability to provide capital to Silicon Valley Bank during this time of crisis. Its role in maintaining the stability of the financial system cannot be overstated, and its continued ability to lend to banks seeking to strengthen their balance sheets will be vital in mitigating risks and safeguarding the sector.

While recent events may have caused concern among investors, the swift action taken by the US government and the steps being taken by the FHLB signal a commitment to mitigating risks and maintaining the stability of the financial sector. The banking system remains secure, and measures are being taken to ensure that it remains so in the future.

Where do we stand?
The recent turmoil in the banking industry has sparked concerns about the potential for wider financial chaos, particularly in the wake of the collapse of Silicon Valley Bank (SVB) and the winding down of operations at Silvergate Capital. While these developments may have far-reaching effects on the crypto and tech sectors, analysts believe that traditional US and European banks have stronger financial buffers now than during the global financial crisis.

SVB’s heavy exposure to the tech sector and bond investments sensitive to interest rate hikes left the company drained of capital and banking customers. However, SVB’s collapse does not necessarily signal more bank failures to come, as the company did not operate like a typical bank. Consumers who were not depositors or investors at SVB are unlikely to be impacted, but the importance of diversification remains true for consumers as well as banks.

Similarly, the announcement of Silvergate Capital’s liquidation marks a significant development for the crypto industry, as the bank served as a major player for crypto companies. While the liquidation plan assures that all deposits will be fully repaid, the plan for resolving claims against the business remains unclear. Investment firms Citadel Securities and BlackRock recently took major stakes in Silvergate, which may now face losses due to the bank’s liquidation.

Overall, the recent developments in the banking industry serve as a cautionary tale for financial companies to not place all their bets on one market-sensitive horse. Diversification is key for both banks and consumers, including putting funds in more than one bank to avoid exceeding insurance limits. While the fallout from the collapse of SVB and the liquidation of Silvergate Capital may have far-reaching effects on the tech and crypto sectors, traditional banks are expected to weather the storm with stronger financial buffers in place.

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