(NEW YORK) — The largest bank failure since the 2008 crisis has triggered a major U.S. government intervention to protect the financial system.
Silicon Valley Bank, the nation’s 16th largest bank, collapsed on Friday, forcing a government takeover and calling into question the fate of almost $175 billion in customer deposits.
On Sunday, Signature Bank, the 29th-largest bank in the U.S., closed its doors, suggesting the financial panic had spread.
Many bank stocks plummeted in early trading on Monday. First Republic Bank dropped 65% before trading was halted; Western Alliance Bancorp fell almost 60%. Charles Schwab, the eight-largest U.S. bank, dropped nearly 10%.
“This has been riding on a roller coaster the last couple of days,” Joe Lynyak, a partner at the international law firm Dorsey & Whitney and an expert on bank failures, told ABC News. “Suddenly, we’re in a crisis.”
Here’s what you need to know about what caused the Silicon Valley Bank failure, how far it has spread and what it means for you.
Why did Silicon Valley Bank collapse?
The failure of Silicon Valley Bank resembles an “old-fashioned bank run,” William Chittenden, a professor of finance at Texas State University, told ABC News.
The bank’s deposit base, which draws heavily from startup firms in the tech industry, tripled in size during the pandemic-era tech boom between 2020 and 2022. Rather than invest all of the deposits into other startups or venture firms, the bank placed a sizable share of the funds into long-term Treasury bonds and mortgage bonds, which typically deliver small but reliable returns amid low interest rates.
In short order, however, the low-interest rate environment evaporated. Over the last year, the Federal Reserve raised its benchmark interest rate 4.5%, the fastest pace since the 1980s. The sudden spike in interest rates dropped the value of Silicon Valley Bank’s Treasury bonds and mortgage bonds, punching a hole in its balance sheet.
Facing a difficult business environment for tech companies, some large clients pulled money from the bank last week and it was forced to sell some of the distressed securities in order to provide the cash.
“When the bank started selling the assets, it became more evidence of the value that they’d lost,” Anat Admati, a professor at Stanford’s Graduate School of Business, told ABC News.
“Imagine that your entire assets are your house and you bought the house with very little down payment and housing prices go down,” Admati added. “You’re basically under water, meaning if you sell the assets, you can’t pay your debt.”
The vulnerable condition of the bank’s balance sheet scared other major depositors, who in turn pulled their funds from the bank, prompting a bank run that gained momentum quickly since the bank depended on a relatively small number of large depositors. It collapsed within days.
“The bank simply didn’t have enough cash on hand to meet all of their depositor needs,” Chittenden said.
Escalating the financial risk, New York-based Signature Bank shuttered on Sunday at the order of state officials. The bank, which had recently welcomed cryptocurrency deposits, fell prey to fears of a bank run among those who held risky assets, Chittenden said.
“The run on Silicon Valley Bank kind of spooked those customers,” Chittenden added. “So Signature Bank went under.”
What did the government do in response to the collapse of Silicon Valley Bank?
The U.S government has taken speedy and extraordinary steps to limit the risk posed to the financial system.
“The government was caught unawares and had to take extreme emergency action,” said Lynyak of Dorsey & Whitney.
Almost immediately, the Federal Deposit Insurance Corporation, which protects the stability of the financial system, took over Silicon Valley Bank on Friday in an effort to protect depositors.
Since the bank is FDIC-insured, depositors are guaranteed protection of up to $250,000 in funds for each different type of account held.
The group of depositors in Silicon Valley Bank is made up of a relatively small set of venture capital firms, startups and other large investors, many of whom held deposits that far exceeded $250,000. In turn, those depositors risked losing a portion of or all of their money that exceeded that threshold.
“Everybody panicked,” Admati said. “They were anxious all weekend long about whether they could make payroll and pull money out because it’s stuck there.”
In response to the outcry and fearing wider spread of the crisis, the FDIC, the Treasury Department and the Fed took further action on Sunday, telling depositors in Silicon Valley Bank and Signature Bank that the FDIC would protect all of their funds, including those that exceed the $250,000 limit.
Later on Sunday, the Fed announced an emergency lending program to cover the deposits at issue and restore wider confidence in the financial system.
Under the program, the Federal Reserve will allow distressed banks to borrow funds on favorable terms directly from the Fed, instead of generating cash by selling underwater securities, as Silicon Valley Bank had done. Those funds will equip banks to pay depositors who may want to quickly pull out funds amid the turmoil.
Now, the banks can use distressed securities as collateral to borrow from the emergency lending program as if the securities had retained their full value, allowing the banks to raise cash and ensuring the Fed will take on much of the risk tied to the banks’ declining assets.
Returning to the analogy of a home mortgage in a declining housing market, Admati said the program resembles a homeowner getting a loan against their mortgage as if conditions had remained as strong as they were when the house was purchased rather than taking into account the new, worse market.
“They’re lending to the bank more than the assets are worth,” Admati said.
The federal agencies behind the emergency response refuted notions that the moves amount to a taxpayer bailout. “No losses associated with the resolution of Silicon Valley Bank will be borne by the taxpayer,” said the official statement from Treasury, the Fed, and the FDIC.
Prominent critics have asserted instead that the government response should be considered a bailout, including the editorial board at The Wall Street Journal.
Has the Silicon Valley Bank collapse triggered a banking crisis?
The collapse of Silicon Valley Bank and Signature Bank has prompted fears of a wider contagion throughout the financial industry.
However, the spread of financial distress remains limited, in part because Silicon Valley Bank served a narrow swathe of the economy concentrated in startup tech firms, some experts told ABC News. Other experts cautioned that the situation continues to be in flux and could escalate significantly.
Chittenden, who downplayed the risk of a wider financial crisis, said Silicon Valley Bank serves a niche market set apart from the economy as a whole.
“It really is relatively isolated,” he said. “It doesn’t have all those interchangeable relationships.”
“It’s not a systemic problem that lots and lots of banks are going to be facing,” he added.
Darrell Duffie, a professor at Stanford’s Graduate School of Business, echoed the sentiment, citing the relatively small size of the failed banks compared to the largest in the sector.
“At this point, it doesn’t look like a broadspread crisis,” Duffie said. “The affected banks have taken more risks than most others and they are not among the very biggest banks, which are more heavily regulated and have a lot more small depositors.”
Admati disagreed, saying recent events should be considered a financial crisis and the outcome remains uncertain.
In rescuing depositors in Silicon Valley Bank, federal agencies invoked the “systemic risk exception,” a stipulation that allows the government to intervene on behalf of depositors.
“It’s certainly a crisis because the bank wasn’t considered systemic and all of a sudden it is considered systemic,” Admati said. “They themselves defined it as bigger than just one failed bank.”
“These things are very hard to predict,” she added, noting that the outcome depends in part on the emotional response and behavior of depositors, which stands apart from the underlying financial damage.
What does the current banking emergency mean for you?
The vast majority of banking customers hold deposits below the FDIC insurance threshold of $250,000, ensuring the protection of funds, regardless of a potential bank collapse, Lynyak said.
The recent bank collapses offer an important reminder that customers should scrutinize the banks that hold their money.
“People should probably be careful about looking at the capital levels and the business plan of their particular bank,” Lynyak said. “Some small inquiry is always very useful.”
As depositors big and small monitor a financial emergency, their assessment ultimately determines the outcome for the wider economy, he added.
“As long as the public believes their deposits are safe, our system is safe,” Lynyak said.
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