Updated: Mar 13
Unless you live under the proverbial rock, by now you've heard of the collapse of Silicon Valley Bank (SVB).
Many factors led to the collapse of SVB, but there is one factor in particular that "regular people" should take a keen interest in ...
... and that's the relationship between interest rates and bond prices.
When interest rates increase, bond prices fall and when interest rates decrease, bond prices rise.
This relationship poses a risk to many banks and companies, and by association, also impacts us "regular people."
So how exactly did the relationship between interest rates and bond prices impact SVB and contribute to its collapse?
SVB invested some of the deposits it received from customers in long-maturity mortgage-backed securities (MBS). An MBS functions like a bond. A long maturity is 10 years or more, and the maturity of a bond/fixed investment is the date you stop earning interest and receive the original investment.
SVB Risk Appetite
The bank put 56% of its assets into fixed-rate (vs variable-rate for example) securities, which is a lot higher than most other banks.
SVB's Bet on Low Rates
As interest rates began to rise, the value of the MBS investments the bank held began to fall. For perspective, the 1-year treasury bill yield rose from 0.05% in May 2021 to more than 5% recently!
SVB Investors and Stakeholders
The declining value of SVB's investment led to a downgrade of their Moody rating, which spooked investors. SVB's stock price began to fall, and panicked customers began withdrawing their deposits from the bank leading to a classic "bank run."
In conclusion, interest rate risk exists and impacts not only banks, but companies who also borrow and invest in fixed securities. Their loans become more expensive - meaning they now have to pay higher interest, thereby impacting their bottom line - or their investments fall in value (like SVB's situation).
This risk that companies and banks take on can impact "regular people" who may not realize their indirect involvement.
There's certainly a lot to unpack and learn for years to come from this historic collapse.
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