Know these first
- L1.4.06: The price-yield relationship
- L1.2.06: Hedge funds and private markets
By the end you will be able to
- 1Explain the interest rate and funding failure at SVB (2023) and the counterparty losses from Archegos (2021).
- 2Show how rising rates create paper losses on safe bonds, and how a deposit run turns them into real ones.
- 3Explain how swaps hid Archegos's concentration, and why the banks that sold first lost least.
- 4Identify the governance and control failures in both cases, and link them to earlier failures.
Why it matters
One bank failed holding some of the safest bonds in the world. Several banks lost billions lending to a single client whose positions none of them could fully see. Neither story needed exotic products. Both needed risks that were visible and not acted on.
Core explanation
Two failures of the 2020s
L2.1.06: Landmark failures: LTCM and 2008 showed leverage, correlation and liquidity at work. These two cases add two more ingredients a risk manager must watch: interest rate risk in the banking book, and concentration, whether in one source of funding or one client.
Silicon Valley Bank, 2023
L1.4.06: The price-yield relationship introduced SVB as a lesson in the price-yield relationship. Here is the whole chain, from the deposit boom to the closure. Spot what failed at each step.
TimelineSilicon Valley Bank, 2020 to 2023
1 / 6 · spotted 0 of 62020–2021
A deposit boom
Silicon Valley Bank served technology start-ups and the venture capital firms behind them. As they raised record sums, the money arrived as deposits: the parent group's assets grew from about $71 billion at the end of 2019 to about $211 billion at the end of 2021 (Federal Reserve review). Loan demand could not keep up, so SVB put much of the money into long-dated US Treasuries and agency mortgage bonds at low fixed yields, many of them classed as held to maturity.
Spot it
What risk did this create?
Archegos, 2021
Archegos was not a bank, and it borrowed through swaps rather than loans. Like the hedge funds of L1.2.06: Hedge funds and private markets, it used leverage; unlike most of them, it kept its positions hidden even from its own lenders.
TimelineArchegos and its prime brokers, 2013 to 2024
1 / 6 · spotted 0 of 5From 2013
A family office with swaps
Bill Hwang ran Archegos Capital Management as a family office. It built positions in shares through total return swaps with several prime brokers: the banks bought the shares, Archegos took the gains and losses and posted margin.
Spot it
Why did swaps keep Archegos's true positions out of sight?
| SVB | Archegos | |
|---|---|---|
| Main risk | Interest rates and funding | Counterparty and concentration |
| Leverage | Thin equity behind long bonds | Swaps worth several times its capital |
| Concentration | One industry's uninsured deposits | One client, a few stocks |
| Liquidity | Deposits left in hours | Blocks of shares could not be sold without crashing prices |
| Controls | Hedges removed, no CRO for months | Limits breached, margin cut, no action |
| Echo of the past | Northern Rock's flighty funding (2007) | LTCM's lenders blind to its totals (1998) |
Try it
A simplified bank, built to show SVB's mechanics, not its actual balance sheet. Raise yields by 3 points first and look at the accounts: nothing seems wrong. Then let depositors withdraw 25%, then 40%. Finally switch on the hedge and run it again.
Try itRates rise, then depositors run
Open the bond pricer →The bank: $10bn cash, $100bn of 10-year bonds bought at par with a 1.5% coupon, $90bn of loans; funded by $185bn of deposits and $15bn of equity.
Interest rate hedge
Raise yields first, then let depositors withdraw.
Worked example
Paper losses, real losses and the race to the exit
Both examples are illustrative. The bank is the one from the Try it; the second example is a stylised Archegos with four prime brokers. Amounts in US$ billions.
A bank, a rate rise and a run
Step 1 of 5- 1
Yields rise 3 points
The 10-year, 1.5% bonds bought at 100 now price at 76.26. The $100bn holding is worth $76.3bn: an unrealised loss of $23.7bn, 158% of the $15bn equity.
The race to the exit
Step 1 of 4- 1
The set-up
A client holds $40bn of one stock through equal swaps with 4 banks: $10bn each. Each bank holds 20% margin, $2bn. The client's capital is the $8bn of margin: leverage of 5×. Each bank sees only its own $10bn.
Regulatory lens
Under the US tailoring rules of 2019, banks of SVB's size faced lighter liquidity and capital requirements than the largest banks, and could leave unrealised losses on their available-for-sale bonds out of regulatory capital. Losses on held-to-maturity bonds stay out of capital at every bank. The Basel Committee's report on the 2023 banking turmoil (October 2023) and the US authorities' own reviews have led to proposals to tighten rules for mid-sized banks and to look harder at interest rate risk in the banking book, which has its own Basel standard. After Archegos, supervisors pressed prime brokers to collect fuller information on clients' total positions and to margin concentrated positions more heavily. L2.6.04: Hedging interest rate risk and M2.7: Introduction to regulation return to both.
Sparks
SparkOne bad month in 2023
SparkThe same lesson, 23 years apart
Key takeaways
- SVB: long fixed-rate bonds lost value as rates rose; a concentrated, mostly uninsured deposit base ran, and selling bonds made the losses real.
- Paper losses are still losses: a bank can be insolvent at market value while its accounts look healthy.
- Archegos: swaps spread across several prime brokers hid one client's huge, concentrated, leveraged positions.
- When a concentrated position must be sold, the first seller loses least: margin must allow for how hard the exit will be.
- In both cases the risks were visible inside the firms; the failure was that warnings and limit breaches did not lead to action.
Reaction
Check what stuck
Question 1 · objective 1
Which combination best explains SVB's failure?
Question 2 · objective 2
A bank has $10bn of equity. Its held-to-maturity bonds are worth $12bn less than their book value. How large is the unrealised loss as a percentage of equity?
Question 3 · objective 3
A bank has a $10bn swap with a client and holds $2bn of margin. The client defaults and the bank sells after the stock has fallen 45%. What does the bank lose, in $bn?
Question 4 · objective 3
Why could no single bank see the full size of Archegos's bets?
Question 5 · objective 4
What control failure do SVB and Credit Suisse's handling of Archegos have in common?
Glossary
- Held to maturity
- Held to maturity: bonds a bank says it will keep until they are repaid. They are carried at cost, so falls in their market price do not show in profit or in regulatory capital for most banks.
- Unrealised loss
- A fall in the market value of an asset you still hold. It becomes a realised loss when you sell.
- Uninsured deposits
- Deposits above the deposit insurance limit, US$250,000 per depositor per bank in the US. Their owners can lose money if the bank fails, so they run first.
- Family office
- A firm that manages the money of one wealthy family. It faces lighter disclosure rules than funds that manage other people's money.
- Total return swap
- A total return swap: the bank buys the shares and passes all their gains and losses to the client, who pays a fee and posts margin. The client has the exposure without owning the shares.
- Prime broker
- A bank that lends to, trades with and holds assets for hedge funds and similar clients.
- Margin
- Collateral a client posts against a position, to cover losses if it cannot pay.
- Concentration risk
- Too much exposure to one counterparty, one asset or one source of funding, so a single event can cause a large loss.
Deep Dives & Origins
Deep Dives
- Board of Governors of the Federal Reserve System, Review of the Federal Reserve's Supervision and Regulation of Silicon Valley Bank, April 2023 (the four key takeaways at the start). Beginner.
- Paul, Weiss, Rifkind, Wharton & Garrison LLP, Credit Suisse Group Special Committee of the Board of Directors: Report on Archegos Capital Management, 29 July 2021. Intermediate.
Origins
- Board of Governors of the Federal Reserve System, Review of the Federal Reserve's Supervision and Regulation of Silicon Valley Bank, April 2023.
- Federal Deposit Insurance Corporation, press releases of 10 and 12 March 2023, and Options for Deposit Insurance Reform, May 2023.
- US Government Accountability Office, Bank Regulation: Preliminary Review of Agency Actions Related to March 2023 Bank Failures, GAO-23-106736, April 2023.
- SVB Financial Group, Form 10-K for 2022 and Form 8-K of 8 March 2023.
- Basel Committee on Banking Supervision, Report on the 2023 banking turmoil, October 2023.
- Paul, Weiss, Report on Archegos Capital Management, July 2021, as above.
- US Securities and Exchange Commission, complaint against Archegos Capital Management and Sung Kook (Bill) Hwang, April 2022.
Module complete
You have finished M2.1: What risk is. Try the Lab Test: case problems on risk and loss, uncertainty, risk and return, why firms hedge, and the great failures.
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