New Delhi. America’s Silicon Valley and Signature Bank are sinking at such a speed that it has become a textbook topic. SVB sank in just 48 hours and Signature Bank did not give any chance to the people. Billions of rupees of people are stuck in these banks. These two are among the three big banks that suddenly closed in America’s banking history. The first was Washington Mutual, which folded in 2008. Now here’s a big question. How did these banks sink when the banking industry is sitting on excess reserves at record levels? Explain that the banking industry has more cash than regulatory requirements.
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Banks are facing these two big risks
The most common risk faced by commercial banks is a surge in loan defaults. It is also called credit risk. But it is not so here. According to economists with expertise in banking matters, this is due to two major risks – interest rate risk and liquidity risk.
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interest rate risk
Interest rate risk in a bank comes when there is a huge increase in interest rates in a very short period. Exactly the same is happening in America since March 2022. The Federal Reserve is aggressively raising interest rates. It has so far increased the key interest rate by 4.5 per cent. The US central bank hiked interest rates as inflation hit a 40-year high. The yield on its date suddenly increased tremendously.
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Yield reached 17 years high
The yield on one-year US Government Treasury notes reached a 17-year high of 5.25 per cent due in March 2023. At the same time, the yield on the 30-year treasury increased by about 2 percent. As the yield on the security rose, its price fell. The yield increased rapidly in a very short period of time. Due to this, the market value of the debt already issued, whether it is corporate bonds or government treasury bills, fell sharply. Long-term debt, in particular, suffered heavy losses.
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Market value falls by 32% with a 2% increase in rates.
For example, a 2 percent increase in the yield of a 30-year bond can cause its market value to drop by about 32 percent. Silicon Valley Bank suffered losses due to this. The bank had a substantial portion of its assets – 55 per cent – invested in fixed-income securities such as US government bonds.
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Big loss if sold before maturity
Of course, the fall in the market value of securities from interest rate risk is not a big problem. Since the investor can hold it till maturity, at that point he will get the original face value without any loss. Unrealized losses remain hidden in the balance sheet of the bank and disappear over time. But if the investor sells the security before maturity when the market value is less than the face value, the unrealized loss becomes an actual loss. That’s exactly what SVB did earlier this year, as its customers began withdrawing bank deposits to meet their cash crunch. Customers did this despite expectations of getting higher interest rates. This created a liquidity risk.
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Liquidity risk is the risk that a bank may not be able to meet its obligations without incurring losses. That is, the bank has to meet the needs of its customers by taking a loss. Let us understand with an example. You buy a house by taking all your savings and a loan from the bank. But suddenly an emergency comes in front of you. Now you need this much amount in this emergency. All your money is locked up in the house and it cannot be sold easily.
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SVB did not have cash to give to customers
Customers were withdrawing their deposits beyond what SBV could pay using its cash reserves. Therefore, to meet its obligations, the bank decided to sell $21 billion from its securities portfolio, taking a loss of $1.8 billion. Due to the decline in equity capital, the bank wanted to raise new capital of $ 2 billion.
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rush to extort money from customers
This intention of the bank gave a big blow to the customers who were already losing their faith in the bank. They rushed to withdraw their money from the bank. There was such a rush among the customers to withdraw their money that even a healthy bank went bankrupt in a few days. In this digital age it is nothing short of a wonder.
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Customers knew money would sink
Part of the reason for this is that many of SVB’s customers had deposits in excess of $250,000 insured by the Federal Deposit Insurance Corporation. So they knew that if the bank failed, their money would not be saved. About 88 per cent of the deposits in SVBs were not insured.
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Same happened with Signature Bank
Signature Bank had the exact same problem. With the collapse of SVB, Signature’s customers also started withdrawing their money from the bank due to liquidity risk concerns. 90% of the deposits in this bank were not insured.
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