Why did Silicon Valley Bank collapse and why it will DEFINITELY happen again!

Today, we're going to take a closer look at fractional reserve banking, the system that underpins our modern banking industry, and explore a contrarian viewpoint on its role in the economy and how it contributed to the collapse of Silicon Valley Bank!

First, what exactly happened to Silicon Valley Bank - explain it to me like I am a child!

Silicon Valley Bank experienced rapid growth from 2019 to 2022, amassing significant deposits and assets. Most of the excess funds were invested in low-risk Treasury bonds and long-term debts.

However, when the Federal Reserve raised interest rates due to high inflation, the bank's bonds lost value as investors sought higher-yield alternatives. At the same time, the bank's tech industry customers faced financial difficulties, leading to large withdrawals.

To cover these withdrawals, the bank sold investments at a loss, ultimately losing $1.8 billion and marking its downfall. Some argue that the bank's troubles began earlier with the rollback of the Dodd-Frank Act, a major banking regulation introduced after the 2008 financial crisis.

Under the 2018 Economic Growth, Regulatory Relief, and Consumer Protection Act, the asset threshold for increased oversight was raised from $50 billion to $250 billion. Silicon Valley Bank, the 16th largest in the country, fell below this threshold, and thus avoided extra regulatory scrutiny. If the threshold had remained unchanged, the bank might have been more closely monitored by regulators.

Most of us have probably not heard about fractional reserve banking, the system that allows banks to hold only a fraction of their total deposits as reserves while lending out the remaining portion to borrowers. This process creates money in the economy and is often credited with stimulating economic growth.

But is it all good news? Let's examine some potential drawbacks of this widely accepted system.

The Dark Side of Fractional Reserve Banking

1. Inflation: While fractional reserve banking increases the money supply and promotes economic growth, it can also lead to inflation. As banks create new money through lending, the total amount of money in circulation increases. If this increase outpaces the growth of goods and services, it can result in a general rise in prices, eroding the purchasing power of your hard-earned money.

2. Financial Instability: The fractional reserve banking system is inherently prone to risks, such as bank runs. If a large number of customers lose confidence in a bank's ability to meet withdrawal demands, they may rush to withdraw their deposits, leading to a liquidity crisis. Central banks try to manage these risks by implementing reserve requirements and other regulations, but history has shown that financial crises can still occur.

3. Encouraging Debt: The growth and prosperity fueled by fractional reserve banking largely depend on continuous borrowing and lending. This reliance on debt can encourage individuals and businesses to take on excessive debt, potentially leading to financial hardships and even contributing to economic downturns.

4. Moral Hazard: Fractional reserve banking can create moral hazard issues, where banks, knowing they are protected by central banks and deposit insurance schemes, may engage in riskier lending practices. This scenario can lead to increased financial instability and even systemic crises, as witnessed during the 2008 financial crisis.

Is There a Better Alternative?

Critics of fractional reserve banking often propose alternative systems such as full reserve banking, where banks would be required to hold 100% of their deposits as reserves.

I MEAN THAT SHOULD BE THE BARE MINIMUM, in my opinion!

While this approach could potentially reduce the risks associated with fractional reserve banking, it may also stifle economic growth by limiting the availability of credit.

The debate surrounding fractional reserve banking is complex, and it's essential to acknowledge both its benefits and drawbacks. As we continue to navigate the ever-changing financial landscape, understanding the mechanics and implications of our banking system is crucial for making informed decisions about our personal finances. It’s no wonder Decentralized Finance and web3 is beginning to gain more traction - especially now.

For the first time in history, people actually have an ALTERNATIVE, to BANKS!

Stay tuned for our next newsletter, where we'll delve deeper into the world of finance and explore more thought-provoking topics. In the meantime, feel free to share your thoughts on fractional reserve banking or any other financial matter by replying to this email or reaching out to me on social media.

Till Next Time

Adi 

You can catch me on Youtube and/or Linkedin (or my podcast)

PS - My new book on financial literacy for beginners titled “Financial Literacy Blueprint” will be launching in the next few weeks, and all you Growth Minded Ninjas will get first dibs! So stay tuned check out the images below for a sneak peak!