In 2021, Silicon Valley Bank (SVB) experienced a huge influx in deposits, jumping from $61.76bn at the end of 2019 to $189.20bn at the end of 2021. With such a large increase in funds, SVB was unable to grow its loan book fast enough to generate the yield they wanted on this capital. As a result, they invested in mortgage-backed securities (MBS) with these deposits for their hold-to-maturity (HTM) portfolio and got an average yield of 1.56%.
However, when the Federal Reserve started raising interest rates back in 2022 and continued doing so through 2023, the value of SVB’s MBS plummeted as investors were able to purchase long-duration “risk-free” bonds from them at higher yields than those offered by MBS. This created liquidity issues for SVB as they had expected their investments would pay out more than what it cost them initially but ended up having to sell off $21bn worth of Available For Sale (AFS) securities at a loss and raise an additional $2.25bn via equity and debt offerings instead.
At first glance, it may seem like banks have some kind of special state-sponsored privilege that allows them to create money or credit with no consequences but this is far from true – banks do not create money out of thin air! Instead, when banks make loans or investments they are transferring literal cash from one depositor’s account into another depositor’s account while making profits on their operations along the way - this is known as fractional reserve banking which refers to how much money banks must keep on hand relative to their total deposits which is usually around 10%. Banks are also subject to various constraints such as reserve requirements that limit how much risk they can take on when making loans or investments – this helps ensure that if anything goes wrong with any particular loan or investment then there will still be enough funds available elsewhere within the bank’s operations so that all customers’ funds can be returned should it be necessary.
The unfortunate incident with SVB serves as an important reminder about why banking regulations exist - without them there would be nothing stopping banks from taking excessive risks with other people’s money which could potentially lead even bigger losses further down the line if something were ever go wrong!
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Author Eliza Ng