They say history repeats itself. To learn our lessons from Silicon Valley Bank, we need to take a trip down memory lane and look at what happened to Lehman Brothers previously.
The collapse of Lehman Brothers in 2008 was a major event that shook the global financial system. The investment bank was one of the largest and most successful in the world, but it filed for bankruptcy after a series of bad bets on the housing market led to huge losses.
One of the key factors in Lehman’s collapse was its use of derivatives, financial products that derive their value from underlying assets such as stocks, bonds, and mortgages. In particular, the bank had invested heavily in high-leveraged mortgage-backed securities (MBS), which were complex products that bundled together thousands of mortgages and then sliced them up into different tranches with varying levels of risk.
Lehman’s strategy was to buy up these MBS and use them as collateral to borrow even more money from other banks and investors. This created a highly leveraged position that was highly risky but promised big rewards if the housing market continued to grow.
However, when the housing market began to collapse in 2007, the value of Lehman’s MBS holdings plummeted. As a result, the bank faced huge losses and could not meet its financial obligations. Its creditors began to pull their money out, causing a run on the bank that ultimately led to its bankruptcy.
The collapse of Lehman Brothers had far-reaching consequences for the global economy. It sparked a major financial crisis that spread worldwide, causing a sharp decline in stock markets, a freeze in credit markets, and a wave of bank failures.
The lessons learned from the collapse of Lehman Brothers have led to increased regulation of the financial industry, with tighter controls on the use of derivatives and other complex financial products. However, the risk of another financial crisis remains, and investors and regulators must remain vigilant to prevent another Lehman-style collapse from happening again.
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After 14 Years: Lessons From Silicon Valley Bank (SVB)
Silicon Valley Bank, a well-known bank in the United States, was recently declared the biggest bank failure since 2008 and the second-largest in US history. This news came as a shock to many people, given that just a year earlier, Forbes had named it one of America’s Best Banks, and Moody’s had given it an A rating.
The bank had been around for 40 years and had been home to half of all venture-backed startups. So how could such a reputable bank fail so spectacularly? There are multiple reasons, but some common culprits have been identified. These culprits are considered “cancers” for the economy and the markets according to Shariah, a set of Islamic laws that guide ethical and moral behavior.
Lessons From Silicon Valley Bank#1
The first culprit is debt trading. Silicon Valley Bank used customer deposits (checking and corporate payroll accounts) to buy bonds. The bank was betting that the Federal Reserve would hike interest rates slowly, but they hiked rates faster than expected, causing the bonds to lose value rapidly. This type of debt trading is not permitted in Shariah.
Lessons From Silicon Valley Bank#2
The second culprit is Riba, which means charging or paying interest on loans. When Riba and debt combine, they create a web of risk in the markets. This exposes everyone to each other’s liabilities, creating a domino effect. The incentive to take on debt is driven by Riba, making it one of the core reasons for the fiasco.
Lessons From Silicon Valley Bank#3
The third culprit is trading what you cannot deliver. This is not permitted in Shariah, and the fractional reserve system, where banks hold only a fraction of their deposits in reserve and lend out the rest, makes banks vulnerable to bank runs.
Lessons From Silicon Valley Bank#4
The fourth culprit is managerial incompetence and moral hazard. There was a mismatch between the bank’s assets and liabilities, and the fractional reserve system created a moral hazard, leading to risky lending practices. Shariah prohibits moral hazard and emphasizes the importance of good governance.
Lessons From Silicon Valley Bank#5
The fifth culprit is the lack of good governance. In 2018, a deregulation bill allowed banks like Silicon Valley Bank to take reckless risks, which would not be acceptable in a Shariah framework. Shariah has controls to reduce the risk of contagion.
Silicon Valley Bank’s collapse will significantly impact the start-up ecosystem, setting it back by 10 years or more, according to some experts. The tragedy is that it is not the wealthy taking the hit but the thousands of companies that borrowed from the bank and were required to keep their cash there.
When debt, Riba, and Gharar come together, don’t expect anything but an eventual collapse and collateral damage. It’s the same old story, over and over again. Hope we all learn our lessons from Silicon Valley Bank.
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About the Author
Mukhriz Mangsor is currently the Head Global Market Strategist at Quantdynamic Research Company. His expertise includes financial education, financial institutions, and property trading with clients, including Brunei, Canada, Malaysia, Singapore, and the United States firms.
