Bank Collapses: 5 Crucial Lessons for Traders

Key Points:

• Diversify your portfolio across sectors
• Understand regulations and safeguards
• Have a contingency plan in place
• Revisit risk management strategies

5 Important Takeaways for Traders When a Bank Collapses

Regarding financial news in March, nothing reverberated around the world faster than when Silicon Valley Bank (SVB) failed on March 10. Until recently, SVB was a commercial bank that primarily served the technology and venture capital industries in the US. It became known as a “startup bank” for its focus on helping emerging tech companies. It even provided financing and banking services to many successful startups that later became industry giants, like Apple, Google, and Tesla.

As inspiring as SVB’s rise is – it held $209B in total assets and $175.5B in total deposits by December 2022 – its fall is anything but. SVB’s deposit holdings surged during COVID-19 as tech startups grew, but their purchased Treasury bonds in 2021 led to a loss in market value due to raising interest rates, which ultimately resulted in an emergency sale and bank run as account holders withdrew $42B on March 9.

Given SVB’s niche industry focus within the US, it’s likely that a lot of traders around the world were not directly affected by this specific bank collapse. Nor the one that occurred a few days earlier when Silvergate Bank, servicing the cryptocurrency market within the States, released a public notice saying that it would undergo voluntary liquidation.

That said, there is always some kind of fallout when a major US bank collapses. Stock markets in Europe fell because of the news and uncertainty of what else might lie ahead, with bank shares dropping in Germany and the FTSE 100 index closing 2.6% lower. So, traders and investors would be wise to regard these recent bank failures as distress signals. After all, SVB’s collapse is the second-largest bank failure in US history and the largest since the 2008 financial crisis.

Using SVB as an example, it’s a good moment to pause and reflect on five key takeaways to consider whenever the banking sector goes through a calamity and banks start to rupture.

5 Important Takeaways for Traders after a Bank Collapses

Diversification

Whenever a massive blow occurs like the one that just hit a few banks in the US, the first thing to always check is whether your portfolio is spread nicely across a wide variety of sectors and instruments. Even if this sounds too obvious to mention, it’s too important not to, because a vast majority of traders – especially those who are just starting out – will end up putting all their eggs in one basket.

In the most recent example, SVB was heavily exposed to the tech sector, and its collapse highlighted the risks of overconcentration in a single industry. Investors who had diversified their portfolios were less impacted by SVB’s collapse than those who had concentrated investments in the tech sector.

Always monitor economic indicators and market sentiment

Hindsight, they say, is 20/20. In the wake of an economic crisis, however big or small, it’s always easier to look back and point to all the signs that now, after the fact, seem obvious. That’s why it’s so crucial to always keep monitoring the health of a country’s economy and the market sentiment of the instruments and industries you’re invested in.

In the case of SVB, the signs were there for those who were paying close attention. The Fed’s interest rate hikes and the ongoing fears of inflation should have prompted any traders or investors who were affected to ensure their capital was secured.

Understand regulations and safeguards

If you’ve ever asked yourself the question “Who reads terms and conditions, anyway?” you’d be well to keep SVB in your thoughts. Whether you’re choosing a broker or choosing a bank, it’s vital that you go over all the regulatory laws, insurance clauses, and any other safeguards they have in place and are bound by. This is how your money is protected and kept safe.

In the case of SVB, when it did its last call report in December 2022, the bank estimated that $151.6B of its total deposits were uninsured. There’s little wonder that what transpired a few months afterward sparked great panic.

Stay informed

In the wake of a major event, it’s very important to stay up to date on any news and developments related to it. What was the impact? How did the government react? What potential systemic risks to the broader financial system have been exposed? Is there a probability for contagion? Asking these questions and evaluating the lay of the land post-crisis is fundamental in being prepared for any future events of a similar nature.

While the US government is assuring everyone that SVB’s collapse is not some premonition of another financial crisis like the one in 2008, traders and investors around the world are understandably on high alert.

Have a contingency plan

We come around full circle to manage your exposure to risk. Portfolio diversification should absolutely be a priority for your risk management strategy even if there appears to be no sign of a crisis. When a major bank fails and an entire sector becomes jittery, however, that’s when it becomes clear that your strategy must include a contingency plan. A typical example that traders will be familiar with is setting up stop-loss orders to help minimize losses in case of unexpected events or market movements.

After the failure of SVB, anyone trading indices, bank shares, the US dollar and other assets would’ve done well to revisit any emergency exit plans they put in place.

The Bottom Line

SVB is just the most recent example of a bank that clearly couldn’t survive in a high-interest rate environment. It caused a small financial hailstorm around the world, and the US government had to react instantly. While a lot of the fears have been assuaged and market sentiment calmed down somewhat, this latest banking collapse is a good wake-up call for all traders and investors around the world.