Silicon Valley bank collapsed, what can be learned from this?

He took it and fell. What happened happened. The Silicon Valley Bank, after 40 years of financing tech ventures in Silicon Valley and beyond – collapsed in a matter of days. And while the consequences must have been painful, the US regulator quickly stepped in and saved the depositors. Will we be wiser from experience when the dust settles? These are three questions that arose after the collapse of the Silicon Valley bank

The fractional reserve system is the basis of modern banking. what is he talking about? The fact that banks do not have to cover 100% of customer deposits. They can “use” this money for other purposes: to invest, to lend to others.

In this way, banks become money creators – as they can borrow money they don’t actually have, they create money “out of thin air”. Banking supervision ensures that they maintain appropriate levels of safety precaution – both capital and liquidity.

This allows credit to be widely available, which is known to be the lever of the economy. That’s why we can get credit cards and bank-financed houses and apartments that we’ll pay for the next 30 years—but also inflation, when credit runs too fast, and the money created becomes too much.

This, of course, generates the risk that the bank will become insolvent in the event of a sudden influx of funds. This is what happened with Silicon Valley Bank. The so-called “running” on this bank means that the SVB has nothing to withdraw money from. And it had to be declared bankrupt.

Why do we need private banks if deposits are ultimately guaranteed by the state?

If a bank operates like any other company, its creditors (that is, depositors) will have to deposit their money. The trustee sells what remains in the bank’s assets – some bonds and other financial instruments, collects outstanding loans, and disposes of the branches and headquarters – and distributes the remainder to the claimants.

However, banks are not like any other company. Because of their crucial role in the economy, a collateral system was invented. This means that deposits up to a certain level are protected from bankruptcy. When the bank turns out to be insolvent, access is made to a special fund, to which banks had previously deposited contributions.

This is not an absolute guarantee – there is usually an amount limit. In Poland (as well as in the entire European Union) this amount is equivalent to 100,000 euros. It’s a little different in the US, but the level of coverage is usually $250,000. What happens when the bank fails? The guarantee fund (BFG in Poland, FDIC in the USA) pays the amount accumulated to each depositor, but not higher than the maximum. All above is lost.

This should be the case with Silicon Valley Bank. Considering that a large group of clients of this institution were investment funds, startups, technology companies and their wealthy owners – only 12% of deposits were covered by guarantees. For comparison – the average for large US banks is about 55%, and in Poland – based on BFG data can be estimated60-70% of the deposit is guaranteed.

But the Federal Reserve decided that if I was a little cynical, it couldn’t let the money of the tech industry and the billionaires and celebrities who made it go to waste simply because they were greedy or careless. Seriously, maybe the Fed wanted to avoid panic and prevent bank inflows. Maciek Danielewicz wrote about the mechanisms and motivations behind this decision.

However, this raises a question – if the banking system is based on a partial reserve system, but when a crisis comes, it turns out that the state guarantees 100% of deposits, then why do we need commercial banks?

After all, their role is to manage risk and create money in a way that allows the economy to grow sustainably. And for this risk management, they can “as a reward” make money from the money that customers bring to them. Since there are no such risks, maybe one state-owned bank will suffice, which gives loans as much as is needed to maintain a balance between economic growth and inflation?

It’s also another time when the central bank – that is, the country – takes out the people who got into it through their own mistakes. The Silicon Valley bank was poorly managed, safety rules weren’t followed, diversification wasn’t taken care of, and when it looked like it was about to crash, the bosses sold shares and paid themselves bonuses.

Fortunately, this time the authorities did not save the owners, but the depositors – although this is also a bad lesson for corporations and the richest clients: after all, it was the Fed who protected them, and not small savers. They can draw conclusions from their – very expensive – mistake: that you do not keep all your eggs in one basket, that the safety of cash also needs to be managed, and not to bring it where it is fashionable and convenient.

One of the most important sentences in Roman law (on which the modern legal system is said to be built) was the sentence: “Ius civile vigilantibus scriptum est”, which means: “Civil law is written for vigilant people”. In a more blunt formulation, it says: “Nec stultis solere succurri,” which means: “You don’t have to get into the habit of always helping stupid people.”

Unfortunately, it turns out once again that in modern capitalism, the person who acts rationally is the common loser.

What are the limits of central bank activity? Did we just meet them?

The task of monetary policy is to ensure price stability. Central banks were established and gained independence from the government and the whims of the electorate to control the value of money.

However, the events of recent years show that central banks are not completely free in their actions. An extreme example – Turkey. Monetary authorities are highly dependent on the executive branch, which, in the person of President Erdogan, has its own ideas on how to fight inflation (or not).

Read also: How far are we from the Turkish text? Is the zloty in danger of the fate of the lira? How do you protect yourself? Did real estate and stocks save the savings of the Turks? Audit

Ours is smaller, but the problem is the same. Although the President does not name the NBP Chairman every year, he often declares sympathy for the ruling party and dislike for the opposition, which is inconsistent with the autonomy of this position. Even worse, the decisions made (whether right or wrong) are driven by factors that are important to the government but do not fall within the NBP’s purview: for example, keeping the unemployment rate low.

The European Central Bank has recently had trouble fighting inflation. When inflation rose sharply and the European Central Bank finally decided to start raising interest rates, it turned out that the bond yields – and with them debt servicing costs – of the eurozone countries referred to as “peripherals”, that is, Italy, Spain and Portugal, rose significantly. The situation became so serious that the threat of bankruptcy appeared in Italy’s eyes.

The European Central Bank, like any central bank, is responsible for the value of the currency. And if one of the eurozone countries goes bankrupt, with a very high probability that the single currency will quickly turn into the same value as the paper on which the banknotes are printed.

Therefore, the ECB had to quickly figure out how to combine policy tightening – that is, raising interest rates and reducing bond purchases – with mitigating sovereign default risk. Launching the program quickly allowed — at least for a while — the biggest fears to be avoided. But the ECB found it had far less room to operate than it thought.

And now we come to the collapse of the Silicon Valley bank. While the true cause of this disaster was mismanagement, it probably would not have come to light had it not been for the interest rate hikes. Tighter monetary policy makes bonds cheaper. In short: because the central bank offers banks a higher interest rate if they deposit their money at it, it raises expectations about bond yields. A higher bond yield means a lower price.

All commercial banks invest in bonds. When interest rates rise, banks incur losses. However, they may charge higher rates of interest for the loans they give to customers, so the net profit must be positive. Well, unless they have a disordered asset structure – as was the case with SVB, but also in many other US banks.

As soon as the Silicon Valley bank crisis hit, investors immediately realized that this situation would curb the Fed’s hawkish tendencies. This means that further price increases will be on a much smaller scale. just a week ago The market was bettingThe Federal Reserve will raise interest rates by 0.5 percentage point at its meeting on March 22. Today, the derivatives valuation shows that an increase of 0.25 percentage points is expected, and even a pause in the cycle.

And inflation does not want to go down that low. Things seem to be going well. But price index readings over the past two months have shown that rapid “inflation” can be a fairy tale.

So it is easy to call a decisive battle against inflation, but time and time again the economy is a very sensitive mechanism to shock changes. Some of the problems central banks face today – those related to unexpectedly discovered business limits – result from earlier decisions of the same central banks.

What will be the consequences of the actions taken today? Nobody knows for sure. A hundred economists and experts will throw their predictions up in the air and one of them is likely to come true. This does not mean, however, that it is a better predictor than the others. Sometimes it is decided by chance.

Is capitalism without strict regulation of banks really better?

Supporters of liberalism often assume that the less regulation an economy has, the faster it will develop. Any barriers only limit human entrepreneurship and breed diseases. Life shows that this is such a naive approach as recognizing that the state is able to satisfy all the needs of citizens, and the free market only hinders this.

The Silicon Valley bank collapse shows that regulation is needed. The more sensitive the industry is to the economy, the more vigorously it must be monitored. The general rule should be: the more damaging a crisis can do, the harder it will be for you to prevent it from happening.

Banking – as I mentioned earlier – is not an industry like any other. Without banks, whether we like it or not, there will be no economic turnover. At least not on the scale it is now.

I typed “banks will pass the cost on to customers” into the search engine and was not disappointed. Every regulation affecting banks probably has an article with this title. Sometimes it’s about less sensible regulations, like credit holidays (although they’re also a high cost to the sector, they’ve contributed to a drop in non-performing loans, which banks carefully record in their annual results), and sometimes it’s about absolutely necessary — like contributions to the BFG.

Whatever the meaning of this phrase (who else, if not customers, are companies supposed to pass costs to?), one has to consider why it is always an argument against introducing regulations?

Even if customers have to spend more on banking services or get a lower interest rate on a deposit – if they get a guarantee that in case of problems their money will not be lost – in my opinion, that’s a price worth paying.

There is no need to complain that you have to present dozens of certificates to the bank when taking a loan. Because if this additional information allows the bank to more accurately assess the risks of such an operation, the total cost to the bank, to the whole system, and finally to the economy will be lower.

Regulations, especially in specialized areas such as finance, are rarely set deliberately by the authorities. Moreover, when designing them, judges should listen to the opinions of experts — although they don’t always have to agree with them. Because I wouldn’t give a penny for the fact that if the regulations they’re subject to depend on the banks, we won’t end up bartering.

Image source: Vali Zmykov/ unplash

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