The fall of SVB and what it means for the financial industry

By Adam Kain

On March 10, 2023, Silicon Valley Bank (SVB), a tech industry service provider for three decades, collapsed due to a bank run. More specifically, SVB was a banker to many tech and life sciences companies with deposit bases well in excess of the $250,000 deposit insurance upper limit. SVB was founded in 1983. Headquartered in Santa Clara, it was a banker to about 50% of all venture capital-funded technology and life sciences companies in the United States. It also had a subsidiary in London, serving tech companies in the UK and continental Europe. The Santa Clara-based lender was then taken over by state regulators, with the Federal Deposit Insurance Corporation becoming its receiver. This made SVB the most significant United States bank to fail since the 2008 global financial crisis, second only to the biggest ever.

What happened?

The pandemic saw many banks, including SVB, receiving more deposits than they could loan out. This caused a huge increase in SVB deposits in 2021, leaving the institution unable to cover the withdrawals of customers. Simply put, the bank’s vulnerability resulted from a high proportion of uninsured deposits and a large proportion of deposits invested in hold-to-maturity securities.

Therefore, the regulators had to intervene and close the bank. The bank was left with an influx of money they had to do something with, so they chose to invest in ultra-safe U.S. Treasury securities.

Unfortunately, when interest rates rose in 2022 and 2023, the value of these securities dropped drastically. This is an expected result since when yields increase, prices decrease, and vice versa. The bank reported a loss of US$1.8 billion from the sale of the securities and was unable to raise capital to make up the difference as their stock declined.

As a result, many VC firms advised their invested companies to take their business away from Silicon Valley Bank, leading to a snowball effect of depositors withdrawing their money. The investment losses and withdrawals were so significant that regulators had to step in to protect depositors and shut the bank down.

What about other banks?

Already, there are signs of pressure on other banks. Trading of First Republic Bank (FRC) and PacWest Bancorp (PACW) was suspended Monday, March 13, 2023, after the stocks plunged 65% and 52%, respectively, while Schwab (SCHW) shares were 7% lower at 11.30 a.m. EST.

In Europe, the Stoxx Europe 600 Banks index, which tracks 42 major European and UK banks, dropped 5.6%, its steepest decline since last March, and Credit Suisse shares were down 9% when writing this blog. US banks had $620 billion of unrealized losses at the end of 2022, assets that had decreased in price but had not been sold yet, according to the FDIC.

To prevent another SVB-style incident, a joint statement by Treasury, the Fed and the FDIC was designed to reassure depositors of other banks that the US government would stand behind bank deposits. Most analysts tell US, and European banks have much more robust financial buffers now than during the global financial crisis, and SVB had a high concentration of investments in the tech sector, which has particularly suffered from rising interest rates.

Why did SVB fail?

SVB’s deposit growth since 2020 has been impressive. The tech boom of 2020-21 meant that many of its tech customers were raising lots of money from venture capitalists and private equity investors and depositing this money with SVB. As a result, its deposits grew from $65 billion in 2019 to $189 billion in 2021—incredibly rapid growth during the pandemic.

The problem for SVB was that, as well as the tech boom end, inflation was increasing and was not likely to be a transitory phenomenon. The US Federal Funds Rate rose from 0.25% in March 2022 to 4.75% by February 2023. This very steep rise in interest rates meant that the low-interest HTM securities held by SVB dropped in value.

Why did the US government step in?

Arguably, many lobbyists and campaign contributions have for many years played a distortionary and influential role in the US financial industry (Igan and Misfra, 2014; McCarty et al., 2015; Quinn and Turner, 2020).

The US Congress enacted deregulation in 2018. This rolled back the regulations introduced after the global financial crisis of 2007-09 – the Dodd-Frank Act of 2010. This deregulation exempted banks with assets below $250 billion – such as SVB – from stress tests and tougher capital and liquidity requirements. In 2019, the Fed further reduced the regulatory burden for all but the largest banks. This allowed SVB to take the risks it did with other people’s money. This may have to be reconsidered for bank stability.

SVB depositors were likely bailed out as monetary authorities would usually reduce interest rates and pump money into the banking system when it faced instability, but as reducing interest rates and engaging in large-scale quantitative easing is not currently available given the Fed’s efforts to tame inflation, tensions between monetary policy and financial stability may well mean that central banks will put the brakes on rate rises for the time being in case other banks face the same fate as SVB. We note that taming inflation isn’t confined to the US but globally as we all battled the once-in-lifetime Covid-19 pandemic together.

What is the future of our banking system?

At the close of 2022, SVB was the 16th largest banking institution in the US, with $209 billion worth of assets. That appears to be a large sum, yet it only amounts to 0.91% of the total US banking assets. Thus, a collapse of SVB would not likely cause any contagion to other banks.

Nevertheless, the SVB situation does point to the risk posed by the investment portfolios of many banks. If interest rates remain on their current upward trend, as the Federal Reserve expects, the value of those portfolios will continue to decrease. Even though these losses will only be realized if the assets are sold, they can still cause a rise in risk levels for certain banks.

It is, however, reassuring to know that most banks possess enough capital to cover any losses due to the Fed’s steps following the 2008 crisis to ensure they remain stable in any situation.

All in all, it is safe to say that the banking system is very sound, and we can be assured not to panic and have faith in it. This is great news for all though perhaps the deregulation issue may have to be revisited.

Image by Gerd Altmann from Pixabay