The Downfall of Banks: A Greek Tragedy Unfolding in Modern Risk Management — Part2

What is an inverted Yield curve?

The yield curve is like a graph that shows the interest rates or yields of bonds with different maturity lengths. It usually slopes upward, which means longer-term bonds have higher yields than shorter-term ones. Basic common sense — You’d want more return if you’re lending your money for a longer time.

Now, sometimes this curve inverts. That means short-term bonds actually have higher yields than the long-term ones.

Why a yield curve can invert?

Market expectations: Investors might expect interest rates to fall in the future. So, they drive up prices of Long-term bonds and pushing down yields (for e.g there is $100 bond which will pay $135 in 10 years, they will sell it for $127 with 7 years left in it, so the person buying it will get less yield) . Short-term bond yields on the other hand might stay higher or even rise because fewer people are interested.

Economic outlook: An inverted yield curve could also signal that investors are worried about an economic slowdown or a recession.

Central bank policy: Sometimes, the central bank, like the Fed, can influence the yield curve by messing with short-term interest rates. If they raise short-term rates aggressively to fight inflation or cool down the economy.

An inverted yield curve has been a historically reliable indicator of a coming recession. It’s like a warning sign that something’s off in the bond market and the economy might be heading for some turbulence.

How BankX_which_failed_last_week got into trouble because of inverted yield curve?

So, there’s this bank, right? Let’s call it BankX_which_failed_last_week. This bank was all about the tech scene — start-ups, venture capital firms, high-growth companies, you name it. It had a different vibe than your typical bank because it was all in on the high-stakes world of high-growth, high-risk businesses.

But then, things got weird with the inverted yield curve and higher interest rates, and it hit BankX_which_failed_last_week like a ton of bricks. Here’s what went down:

Inverted Yield Curve: So, when the yield curve flips, people get all freaked out, thinking the economy’s gonna tank or something. And for BankX_which_failed_last_week, that meant their clients — the start-ups and high-flyers — might hit some major turbulence. Funding gets tight, valuations drop, and growth prospects nosedive. The bank’s loans suddenly look shakier, with more defaults and fewer new loans.

Higher Interest Rates: When rates go up, it gets pricey for companies to borrow money. For tech companies that need cash to fuel their growth, this is a big deal. Higher rates make it tougher for them to raise capital, which can slow them down and boost the risk of default. That’s bad news for BankX_which_failed_last_week’s lending biz, leading to slower loan growth and riskier credit.

Impact on Venture Capital: BankX_which_failed_last_week was tight with the venture capital crowd, and those guys fund a lot of start-ups and high-growth companies. When interest rates climb, it gets harder for venture capital firms to raise funds for their investments. That means less money for start-ups and innovators, which can hurt BankX_which_failed_last_week’s business.

Interest Rate Spread: Banks make their dough by borrowing at low short-term rates and lending at higher long-term rates — that’s the interest rate spread. But when the yield curve inverts, the spread between short-term and long-term rates gets all squeezed, which can hurt a bank’s profits. Since lending was BankX_which_failed_last_week’s main gig, a smaller spread could hit their bottom line.

So, to sum it up, an inverted yield curve and higher interest rates were like a one-two punch for BankX_which_failed_last_week. Economic slowdowns, pricier borrowing for high-growth companies, less venture capital cash, and squeezed interest rate spreads all piled on the pressure, leaving the bank reeling and its operations hurting.