The approach entails finding banks that manage their exposure better, with Silicon Valley Bank serving as an example. Because of the zero-interest-rate policy environment, they bought long-term bonds in quest of greater yields, but had to sell them when depositors demanded their money back. When the pandemic struck and fiscal stimulus measures were implemented, banks enjoyed a liquidity infusion from PPP loans and stimulus checks. This resulted in a 40% increase in the broad money supply, primarily through bank deposits.
Notwithstanding the fact that these are customer monies, the banks must invest them in something. Several banks preferred to invest in relatively secure securities with longer durations, such as treasuries and mortgage-backed securities, but this caused a concern because they were subject to interest rate spikes.
The combination of a record growth in the broad money supply and low interest rates caused inflation, prompting the Federal Reserve to fully alter its monetary policy. They started withdrawing money from the system and raising interest rates at the quickest rate since the 1970s. As a result, banks that had invested in longer-term, secure assets found themselves submerged.
There were two primary risk factors that contributed to Silicon Valley Bank's severe difficulty. For starters, their deposits were of poor quality because they were predominantly from the IT startup industry and were mostly commercial bank accounts that exceeded the FDIC limit. This exposed their deposit base to loss if there were any signals of danger. Second, they failed to manage their duration effectively and placed a large bet on long-term assets, which was dangerous owing to price risk.
While this was hardly the most risky investment, it did result in huge losses for the bank. Banks like JP Morgan, on the other hand, chose shorter-term assets and hence incurred fewer losses as interest rates rose.
Silicon Valley Bank had a volatile deposit base in comparison to its capital. This was a risk profile shared by other banks that had either failed or were about to fail, as they all had unrealized losses and similar deposit concerns. Banks that performed better, on the other hand, had a more diverse and larger deposit base, held shorter period securities, or had a substantial proportion of their own loans on their books that were not exposed to market volatility.
Silicon Valley Bank had to mark their long-term bonds to market and experience losses when they had to sell them. They sought to obtain equity but were unable, resulting in their failure that weekend.
In summary the approach to managing bank exposure involves finding banks that manage their exposure better. They bought long-term bonds in search of greater yields, but had to sell them when depositors demanded their money back due to the pandemic and fiscal stimulus measures. This resulted in a 40% increase in the broad money supply, leading to a record growth in the money supply and low interest rates. This caused inflation and the Federal Reserve to alter its monetary policy, leading to banks that had invested in longer-term, secure assets becoming submerged. Banks that performed better had a more diverse and larger deposit base, held shorter period securities, or had a substantial proportion of their own loans on their books.
Source:
Swan Bitcoin, 20 March 2023, "Lyn Alden: Explaining the Bank Collapse",