As I understand it, here's a very simplistic explanation of what happened with Silicon Valley Bank.

[LuckyCharms]

Last edited Sun Mar 12, 2023, 01:01 PM - Edit history (2)

Large depositors place their money into accounts at Silicon Valley Bank (SVB).

Banks want to earn a return on that deposited money, instead of letting it sit there, earning nothing for them.

Banks invest deposited amounts into some type of financial vehicle in order to get a return on the deposited funds for themselves. For example: money market funds, CD's, mortgage backed securities, maybe a small portion into the stock market, etc.

Risk management at a bank would perform detailed analyses to make sure that the investments the bank made with deposited money would not hamper the ability for bank customers to withdraw their funds. This analysis would include balancing the risks inherent in whatever the bank invested the depositor's funds in . The bank would need to make worse case assumptions to ensure that they are liquid enough to provide the cash to customers in cases where, for example, withdrawals would for some reason increase by X%. In other words, the bank would have to be very conservative and assume an increase in normal withdrawal rates. They would have to factor in a "buffer" so to speak, should withdrawals increase. This means that a particular percentage of SVB's investments would have to remain very liquid (quickly and easily converted to cash).

Before Trump took office, certain banks holding $X in deposits were subject to "stress tests" by federal regulators to ensure the banks were liquid enough to provide depositors their money should the amount of withdrawals increase above a "normal" amount.

Trump did away with the regulations that required certain banks to be stress tested to ensure that their investments, using depositor's money, were not subject to unusual risk.

SBV over-weighted the amount of depositor's funds that were used to buy long-dated government bonds.

Long dated government bonds are subject to a particular type of risk known as "interest rate risk".

Here's the mechanics of this risk:

Bank buys a government bond with depositor's money in order to earn a return on that money for themselves. The bond has a par value (face value) of $1,000, and since the bank was purchasing these bonds when interest rates were low, the bond pays 1% interest per annum (I'm just making up numbers here for this example).

The fed increases interest rates in order to try to slow down inflation. This means that all interest rates rise. Credit card interest, savings deposit interest, money market interest, mortgage interest, etc.

A large depositor who placed cash into an SVB account comes in and wants to withdraw $200 million. Because the bank placed most of their deposited funds into government bonds (they over-weighted their investments in bonds and did not hold enough deposits in more liquid investments like cash or money market funds), the bank does not immediately have the cash to give to the person making the large withdrawal.

To get the $200 million to the person withdrawing, the bank has to go out and sell $200 million of the bonds they bought.

However, now they have to find a buyer for the bonds on the open bond market. The bonds are paying only 1% interest since the bank bought them when interest rates were low. The person who is buying the bonds from the bank is going to want to earn more than 1% interest, because interest rates are higher now, and more than 1% can be made in other investments by the bond purchaser.

So in order to make a percentage greater than 1%, the purchaser of the bonds will not buy the bonds for what the bank paid for them ($200 million). The purchaser of the bonds will pay less than the face value of the bonds, so his return will be comparable to that of which could be made in other investments. Therefore, the bank loses money on the bonds that they sell in order to cover the withdrawal.

Selling bonds takes a bit of time, which means that if the bank is over-weighted in government bonds, and don't have enough liquid assets to cover the withdrawal, the the person trying to withdraw their money may have to wait until the bank sells some bonds for cash in order to give the money back to the depositor.

Once this happens a few times, word gets out, and more and more people start withdrawing their money from the bank out of concern for the banks stability.

Summary:

Trump eliminated regulations for certain banks to be stress tested in order to ensure that they are liquid enough to provide customers with their funds should the amount of withdrawals increase above a normal amount.