Understanding how the global markets are affected and the potential impact on future economic policy of the Federal Reserve
Who is Silicon Valley Bank?
Silicon Valley Bank (SVB), once one of the 20th largest banks in the United States, recently reported a nearly USD 2 billion loss due to investments in assets directly exposed to interest rate fluctuations. This has caused client panic and a bank run, something not seen since the Global Financial Crisis (GFC). The bank is insolvent, and trading in its shares has been halted. The failure of Silicon Valley Bank and its implications for the global market could have direct effect on FED monetary policy in the upcoming week.s
Why Silicon Valley Bank Collapsed?
SVB has been in business for 40 years and has a market cap of more than USD 200 billion. The recent loss, however, was primarily due to investing in 3.6 year duration assets with a low yield of securities at 1.79%, such as bonds, mortgages, and others. High interest rates have had a direct impact on the value of these assets, which have depreciated significantly during the interest rate hike cycle. This has resulted in potential losses, particularly for banks that are required to sell in order to service liquidity or cash flow, which could eventually become a real loss.
The AFS Portfolio was worth USD 21 billion, and the bank was forced to sell and take a loss. The bank then stated that it was attempting to raise USD 1.3 billion. This capital raising ultimately proved to be a double-edged sword, as the bank was unable to complete the share offer. Furthermore, companies such as PayPal advised its subsidiaries to withdraw all funds from Silicon Valley Bank as a precaution, causing a chain reaction. What was supposed to be a simple capital raise turned into a disastrous scenario of illiquidity that quickly became an insolvency situation.
How the Banking System Works?
Banks are places where we can keep our money safe while also paying bills, transferring money to friends, and borrowing money if necessary. When we deposit money in a bank, it is not simply stored in a large vault somewhere. Instead, the bank lends that money to other people and businesses in need. The idea is that the bank can profit by charging interest on those loans and then use that money to pay interest to those who have deposited money with the bank.
Nonetheless, things don’t always go as planned, as was the case with Silicon Valley Bank. For example, if a large number of people withdraw their money all at once, the bank may not have enough cash on hand to reimburse everyone. This is what we mean by “liquidity” – it is a measure of how easily a bank can convert its assets (such as loans and investments) into cash if necessary.
If the bank lacks liquidity, it may become “insolvent,” which means it does not have enough money to pay all of its debts. This is clearly a bad situation for the bank and the people who have deposited money with it.
Illiquidity quickly become Insolvency with Silicon Valley Bank
Illiquidity is a short-term cash flow problem, whereas insolvency is a more serious situation in which a bank’s overall financial health is jeopardised. Both illiquidity and insolvency can have serious consequences for a bank’s customers, employees, and the broader economy, which is why regulators closely monitor banks and take precautions to avoid these situations. Banks are far more capitalised than they were prior to the GFC, making them far more comfortable than they were before the GFC as you can see in the illustration below. However, there is always the possibility of insolvency should another chain reaction occurs.
Silicon Valley Bank’s failure has had an effect on the overall stock market, with SVB shares falling from $260 to $82 in two days and being suspended from trading on the Nasdaq. The bank announced that it would seek a buyer to take over the entire institution. Although there is always a small risk of contagion, even the largest banks in the United States would run out of liquidity if everyone withdrew their funds at once. Nonetheless, this is how the entire banking system operates and it would be unlikely to happen.
Silicon Valley Bank’s failure has highlighted the importance of understanding the risks of illiquidity and insolvency in the banking system. It has also highlighted the impact of interest rates on bank assets and how this can result in potential losses. As the world markets continue to be affected by this event, it is critical to monitor how it will affect the broader economy and how regulators will respond to prevent similar events from occurring in the future.
Could the Silicon Valley Bank Collapse impacted on future FED monetary policy?
After the event of Silicon Valley Bank failure, the markets have already started to speculate that interest rates could be down from probably pivot of 5% to 4.5% in July 2024, therefore suggesting that we may see FED injecting liquidity back in the system, sooner than expected.
We hope it helps you to understand the impact of Silicon Valley Bank failure and what are the latest FED predictions for interest rates.
What kinds of stocks tend to outperform when interest rates fall?
- Growth stocks
- Technology stocks
- Consumer staples stocks
- Real estate stocks
But keep in mind these stocks can still suffer in the short term, until we see the pivot of interest rates.
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