The Financial and Legal Challenges When Banks Collapse

Banks and financial institutions can collapse for a variety of reasons. For example, the 2008 world financial crisis was a result of high-volume loans, poor lending standards and falling house prices.

Silicon Valley Bank is the latest to suffer collapse, mainly due to failing investments and the rapid withdrawal of customer deposits.

With the future of other banks also hanging in the balance, it’s clear that these situations can create ripple effects across the sector.

What is SVB, and why did it collapse?

Silicon Valley Bank started in 1983, offering financial services to digital tech businesses, something that the more traditional banks had never provided due to the risk. As technology has advanced so rapidly throughout recent years, SVB gained huge customer deposits at a rate never seen before.

The bank chose to invest this in long-term bonds and home improvement products, but as interest rates rose, their investments lost value. Customers soon got wind of the issues and began pulling their money, leaving Silicon Valley Bank in crisis and clients looking for solutions.

The bank was soon taken over by First Citizens, while the UK arm, SBV UK, was bought by HSBC. These deals are hoped to help offer reassurance that there’s unlikely to be a repeat of the 2008 crash.

What are the risks of a bank collapse?

The fallout of bank collapses can be complex, but a few main issues can often arise.

Loss of customer deposits

This is usually the customers’ main concern when a financial department ends up in crisis. Fortunately, those who banked with SVB were given full access to their deposits. However, shareholders are likely to lose theirs.

It’s a good idea for investors to seek professional advice, especially if the SVB collapse has impacted them. While it’s easy to panic and pull out investments, assessing risk and long-term goals before transferring deposits into cash is worthwhile.

Loss of funding

Due to the nature of SVB, some start-ups might struggle, especially initially, to gain access to funds through venture debt.

When any bank collapses, access to some financial products and services is likely to be unavailable or, at the very least, a slow process until any takeovers are complete. This, in turn, can have a knock-on effect throughout the economy as businesses struggle to fund growth.

Legal contracts and agreements

Any legally binding contracts between parties, including with a collapsed bank, are usually transferred to bridge banks before any takeover. The contracts should be honoured by both parties as previously agreed.

How can investors deal with collapsed banks?

This depends on the location and deposit amounts. In the UK, the Financial Services Compensation Scheme offers protection for up to £85,000 per person per financial institute. So, if a bank collapses, customer deposits up to this limit will automatically be protected.

As there are some signs of a slight domino effect with other major banks, such as Credit Suisse and Deutsche Bank, facing trouble, it’s too early to tell if it signifies a global crisis. Investors are likely to be worried about their assets but should assess any potential decision before pulling their cash or making hasty investment decisions.

Although, so far, banks have been rescued and a full financial crisis has been averted, there’s still a sentiment of caution amongst investors. Institutions need to assess their risk management strategies, and regulators should take a view of the whole market to avoid situations like the SVB collapse.