It’s not uncommon for a bank to collapse. In the 246-year-long history of the USA, thousands of financial institutions failed, without the slightest chance of being salvaged. During the Great Depression of the 1930s only, a colossal 9,000 banks faced insolvency. At the time, about $140 billion of depositors’ cash vanished into thin air.
But what does it mean for a bank to “fail”? Generally speaking, a bank is considered to have collapsed when the market value of the bank’s liabilities—amounts owed to depositors and creditors—exceeds the value of its assets.
The reasons for this may vary. Some of the most common ones are bad investment decisions leading to irreparable losses, or systemic weaknesses when the entire economy is having hard times. Of course, there could be some unforeseen events that have caused the failure, such as the COVID-19 pandemic in 2020, when four banks collapsed in the USA.
What precisely happened with the three banks? Could it be predicted that they would fail? Unfortunately, it’s difficult to foresee if or when the bank will collapse. As we have seen from the case of Silicon Valley Bank, neither age nor expertise can vouchsafe resilience.
A tale of two banks
Forty years ago, in 1983, Silicon Valley Bank (SVB), that was to become the most preferred bank in the tech sector was born. Headquartered in California, the bank gradually grew to become the 16th greatest financial institution in the USA. Before its failure caused by a range of poor investment decisions, the bank catered for the financial needs of tech companies worldwide.
Five years later, another California-quartered bank was founded – Silvergate Bank. Initially, the bank focused on providing lending services to industrial customers. In 2013, 15 years after its foundation, the bank started to pursue cryptocurrency companies, becoming one of the first crypto banks. At the time, other financial organizations were hesitant to deal with crypto owing to the intransparency of the sector.
As SVB was the main choice of banks for the tech industry, its services were highly sought-after throughout the pandemic period. With the rise of remote work, consumers started spending huge amounts of money on digital services and gadgets. This quickly turned into a golden goose for renowned tech companies and startups.
Many tech corporations employed SVB to store the cash they used to cover business expenses and payroll. Logically, this led to a massive flow of deposits. As banks normally do, SVG used an extensive portion of those deposits to make investments. So far, so good, there seemed to be no problems.
A seed of demise
The seeds of SVB collapse were planted the moment it started to invest in long-dated US government bonds, involving those that were supported by mortgages. In all actuality, they were as safe as houses. Or they seemed to be.
The problem with bonds is that they are inversely related to interest rates. In other words, when interest rates rise, the value of bonds decline, and vice versa. Therefore, when the Federal Reserve began to rapidly increase interest rates to fight inflation, SVB’s bond portfolio began to lose value significantly.
Were the bank able to hold the bonds for a while until they mature, it would have got its capital back. Nevertheless, many of the bank’s clients started withdrawing from their savings as the economy deteriorated during the previous year. As SVB didn’t have enough cash on hand, it started selling some of its bonds at high losses, further alarming both clients and investors. It took only 48 hours between the time the bank revealed it had sold its assets and its failure.
The bank run has started
Considering the fact that banks hold only a portion of their assets as cash, they are prone to a rush of demands from customers. Though the problems of Silicon Valley Bank originate from previous investment choices, the bank run was initiated on March 8, when SVB disclosed raising a capital of $1.75 billion. The investors were informed the bank needed to “plug a hole” made by selling its loss-making bonds.
When customers became aware of the deep financial problems SVB was in, they started to withdraw money panickingly. Only two days after the announcement of raising capital, the US company worth $200 billion crashed, marking the greatest bank failure in the USA since the world financial crisis.
But how about the Silvergate Bank?
Remember the fall of the notorious FTX exchange and its sister company Alameda? Well, FTX was among Silvergate’s great customers. Following the FTX collapse, Silvergate was subjected to investigation initiated by the US Department of Justice. On March 1, the bank informed the regulators that it was reviewing a number of pending regulatory and other inquiries involving the company.
Source: Ledger Insights
That day, Silvergate stock dropped by almost 58%. Needless to say, clients started fleeing the bank, requesting to have their deposits back. With only $3.8 billion in digital assets reported on December 31, 2022, the bank had no choice but to announce it was closing down.
Is the bank run to blame?
In broad strokes, the same problem—classic bank runs—was what brought down both banks. Be it crypto exchanges or software firms, their former clients are currently dealing with significant commercial difficulties, partly due to the current financial and economic climate. As a result, deposits have decreased and cash withdrawals have increased at a time when many of the banks’ long-dated non-cash holdings have also been negatively impacted by the markets.
Becky Sarwate, Head of Communications at CEX.IO also agrees that the massive bank run led to the bank collapse. “At the core, it was liquidity trouble (or the risk thereof) that caused these institutions to be closed by regulators. Too many depositors demanded cash at once, and these institutions couldn’t convert loans, securities (e.g., MSBs and bonds), and crypto to cash quickly enough to meet demand. In some cases, they were forced to realize losses on these assets to cover deposits.”
But here we encounter an underlying problem – why did depositors want their cash so badly? “Simply put, banks are over reserved only offering .5% on deposits when the market is paying 4.5% to 5%. Depositors began to withdraw their cash en masse to funnel it into money market accounts, bonds, and other higher-yielding instruments. The banks simply couldn’t meet the demand for withdrawals and the run and contagion fears began,” Becky Sarwate commented.
Signature Bank – the last to fall?
The third, and hopefully the last bank to fail was crypto-friendly Signature Bank. The New York-headquartered financial organization fell subject to the Department of Justice investigation to prevent money laundering. The regulators swiftly took control over the bank on March 12, making it the third largest bank collapse in US history in only four days.
Source: New York Post
Many were surprised by the decision to close the cryptocurrency-friendly bank, which provided loans to businesses in the digital asset sector and enabled crypto-to-fiat transactions via its Signet network. The reason for closing was not clear, so it’s not surprising why people believed this move was sending “a very strong anti-crypto message.”
Regulators denied the accusations, explaining that the decision to shut down the bank was not related to crypto. The alleged reason was a “crisis of confidence in the bank’s leadership.” Still, people didn’t buy it.
Playing a blame game
Unlike the November 2022 collapse of FTX, this time the crisis didn’t appear to revolve around the crypto industry, though this doesn’t mean it wasn’t affected. Still, the bank collapse has led to some finger-pointing. Namely, after a more than tough year of serious ups and downs, crypto investors and executives grabbed an unprecedented opportunity to preach and scold.
According to them, it was centralized banking to blame. These crypto investors claimed the recent crackdown by government officials on cryptocurrency businesses had sowed the seeds for the collapse of the bank. For them, their idea of a different financial structure that wasn’t dependent on large banks and other gatekeepers was superior.
At the end of the day, it was a problem that started in the greater banking system. Each of the banks at the forefront of the crisis were engaging in activity they were expressly permitted to do. Aggressive monetary policy, coupled with how banks are outlined to operate (most notably partial reserves) sit at the center of the issue.
Becky Sarwate, Head of Communications at CEX.IO
The fingers were also pointed from the opposite direction, too. Some tech investors claimed the Silicon Valley Bank crisis was caused by the bad actors and overnight collapses that plagued the cryptocurrency realm. These unfortunate events have evidently pre-trained individuals to panic at the first hint of difficulty. FTX, Sam Bankman Fried’s crypto exchange closed down in November following a crypto-equivalent of a bank run, revealed a sizable hole in its financial records.
In addition, some lawmakers jumped to the conclusion that the crypto industry is to blame for the bank crisis. The reason – its struggle to recover amidst rising interest rates. But how are decentralized crypto industry and centralized banks related?
Apparently, a major crypto company by the name of Circle, also known as the issuer of the USDC stablecoin, disclosed on Friday, March 10, that billions of dollars ended trapped in SVB. Consequently, USDC, the company’s coin, lost its peg to USD, dropping below $1.
The aftermath of bank crisis
Taxpayers and depositors are as safe as houses, as they won’t experience any consequences. The US Treasury, Federal Reserve, and Federal Deposit Insurance Corporation (FDIC) declared that depositors at SVB would have full access to their deposits starting Monday. Thanks to the bailout, there will be no aftermath for SVB clients regardless of whether they insured their funds or not.
In what was the largest bank collapse in the US since 2008, investors were left out. This was possibly the first time that the government refused to bail stakeholders out but decided to help its taxpayers instead. Joe Biden, the US President, was happy with the bailout initiative. However, he highlighted that there still would be consequences from the crisis.
How about the crypto sector?
The collapse of two crypto-friendly banks and the greatest bank for tech startups in only one week certainly didn’t go without any consequences. When the news about SVB collapse spread, crypto prices immediately dropped. However, on Sunday night, after the government announced it would provide a backstop for depositors in two of the banks, the cryptocurrency prices rallied almost immediately.
But how far-reaching will the aftermath of the bank crisis be when it comes to the crypto industry? According to Becky Sarwate, it may require centralization to some extent. “The industry lost two of its biggest banking partners, in turn, forcing companies to centralize around a smaller pool of prospective partners. Centralization is negative in that the failure of one piece of the puzzle can result in outsized impact on more parties,” Becky explains.
Though not directly impacted as bank stakeholders and investors, crypto holders might experience the effects of the collapse as well.
For crypto holders, there may be hindrances in getting cash in and out of the market. The banking relationships maintained by crypto companies are centered primarily around moving fiat funds. Hold ups at the intersection of crypto companies and banking partners can influence this rail.
Becky Sarwate, Head of Communication at CEX.IO
Possibly the most impacted, in addition to bank stakeholders and leadership, were specific crypto companies that had money in Silicon Valley Bank. Those are:
- Yuga Labs
- Nova Labs
- Dapper Labs
The company that might have felt the gravest consequences of the bank crisis was, as mentioned above, Circle. In its statement, the company disclosed that Silicon Valley Bank was among six banks Circle relied on to manage USDC cash reserves.
As a result, USDC lost its peg, dropping below $0.9. Other affected stablecoins included DAI, USDT, USDP, and FRAX. Becky Sarwate, however, reassures us that there’s no room for panic. “Stablecoin depegging has already occurred and has since been resolved. This most notably happened to Circle’s USDC, which had $3.3 billion of its $40 billion backstop (8.3%) held at SVB. Other stablecoins also depegged as panic briefly spread across the market. However, all major stablecoins have returned to their intended reflection of the dollar. These stablecoins include FRAX, USDT, and USDP.”
The light at the end of the tunnel
Following the failure of Silvergate, Signature, and Silicon Valley Bank, the cryptocurrency markets have been in an uphill battle. Yet, despite what could have had a horrible effect on the crypto industry, the prices of Bitcoin and altcoins rallied. For the first time this year, Bitcoin broke $26,000, driving the price of other cryptocurrencies as well. The surge in the value came after the regulators announced all SVB depositors would be able to access their money.
Hence, the bank crisis need not bring about detrimental effects on the crypto realm. In fact, markets are now anticipating the regulators will be less aggressive with interest rate surges. According to some analysts, the rise of Bitcoin and other cryptocurrencies amidst the bank crisis seems to be the consequence of the “apparent fragility of the banking system.” In their view, cryptocurrencies may arise as risk-off assets, offering asylum from fragile centralized financial institutions. Just as a reminder, Bitcoin came into existence in 2009, a year after the 2008 financial crisis, most likely as a reaction to unfair bailouts.
Therefore, could the bank failure and consecutive crisis mean the end of the crypto winter? Could be, but not necessarily. “I think all metrics and data point to “crypto winter” already heading toward an end in early 2023, even before the U.S. banking crisis even came about. If anything, the bank failures merely drive home the permanent interconnectivity between TradFi and DeFi. What happens to one necessarily impacts the other now,” concludes Becky Sarwate, Head of Communications at CEX.IO.