The past 48 hours have been witness to one of the biggest bank failures in the US history. What makes this even worse is that it highlights a huge blind spot for the entire banking industry. While it might seem like an isolated event, further investigation reveals that the whole banking system could be vulnerable, and the saying 'too big to fail' could be tested again soon.
This article aims to provide an objective view of what is happening, the safety of your money, and what you can do to ensure you're best protected.
The Failure of Silicon Valley Bank
Silicon Valley Bank was founded in 1982 and quickly became a prominent lender in Silicon Valley, catering almost exclusively to venture capital. Essentially, it became the start-up's bank where CEOs and businesses would go for funding. For several decades, this worked out incredibly well, until recently. In 2020, interest rates were reduced to zero, and stimulus measures were put in place. Both banks and people were flush with cash, and almost all of it funneled back into the banking system, which is where things began to go wrong.
Fractional Reserve Banking
Banks currently operate on what is called fractional reserve banking. This means that banks are required to keep at least 10% of their customers' money available at all times for withdrawals. The remaining amount can be loaned out to other customers, who then deposit that money back into the banking system. This process is repeated, resulting in banks hoping that enough people will give them deposits, so when the first person wants their money back, they'll have enough cash on hand to handle withdrawals. This system allows customers access to a much larger pool of money, and banks can earn interest on their deposits. However, it also relies on everyone having faith that the system works and not all pulling their money out at the exact same time.
The Danger of Bank Runs
If people start withdrawing their money all at the exact same time, it could lead to what is called a 'bank run.' This scenario is what led to the Great Depression in the 1930s. The danger of bank runs is that it can lead to a vicious cycle. When people start withdrawing their money, it leads to panic, and other customers start withdrawing their money as well, which could cause banks to fail. The failure of banks could lead to a loss of confidence in the entire banking system, leading to more bank failures, and ultimately, an economic collapse.
How the Banking System Works
To understand the vulnerability of the banking system, it's essential to understand how banks work. Banks take your money, loan out a portion of it, and invest the rest in safe and stable investments like US treasuries. This ensures that as long as those treasuries are held to maturity, the bank gets near the guaranteed rate of return. Customers could be made whole, and everyone wins. However, this scenario relies on banks investing in safe and stable investments.
The Risk of Investment in Bonds
In 2021 and early 2022, Silicon Valley Bank took roughly a hundred billion dollars and invested that into government-backed bonds. A significant portion of that was locked away for three to four years at an interest rate of just 1.79%. Essentially, this meant that Silicon Valley Bank took a massive bet that the Federal Reserve was not going to raise interest rates as fast as they did. When they turned out to be wrong, it put them in a very dangerous position. Bonds are valued based on their yield, and in this case, Silicon Valley Bank was on the wrong side of the transaction.
So, what does this mean for you and your money? Is your money safe? The answer is, it depends. If your bank is not directly impacted by the failure of Silicon Valley Bank, then your money is still safe. However, the larger issue here is the potential for a domino effect in the banking industry.
If people begin to withdraw their money en masse from banks, this could cause a liquidity crisis, where banks do not have enough cash on hand to handle all of the withdrawals. This is what happened during the 2008 financial crisis, and it's what the "too big to fail" concept was supposed to prevent. However, with Silicon Valley Bank's failure, we are now seeing that there are still blind spots in the banking industry that could lead to similar crises in the future.
So, what can you do to protect yourself and your money? First and foremost, it's important to diversify your accounts across multiple banks. This ensures that if one bank fails, your money is still safe in other accounts. Additionally, it's a good idea to keep some cash on hand in case of emergencies.
It's also important to keep an eye on the financial health of your bank. Look up their financial statements and make sure they are in good standing. If your bank is struggling, it may be a good idea to withdraw some of your money and transfer it to a more stable bank.
Overall, the failure of Silicon Valley Bank should serve as a wakeup call to the banking industry and to consumers. We need to be more vigilant about the health of our banks and ensure that we are protecting ourselves from potential crises.
In conclusion, while the failure of Silicon Valley Bank may seem like an isolated incident, it is actually a warning sign for the entire banking industry. It's important to be proactive about protecting your money and diversifying your accounts to ensure that you are not impacted by potential failures in the future.
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