On the 10th March 2023, one of the most protuberant lenders for technological start-ups, the Silicon Valley Bank (SVB) got collapsed. The 40-year-old institution was taken over by the Federal Deposit Insurance Company (FDIC) last week. This is the second-largest bank failure in U.S. history and the largest since the 2008 financial crisis. The SVB’s failure raises numerous issues, like how it got into this position, what lessons can be learned, & whether anyone will trust SVB or any other bank that acquires it. This article intends to answer these questions and more.
Collapse of Silicon Valley Bank
The 16th Largest Lender in the US, the Silicon Valley Bank went bust with about $200 billion in assets. The financial position of SVB has worsened over the years. Two days before (i.e. on 8th March 2023) it collapsed, the Bank announced that it was seeking to raise $2.5 billion to replenish its balance sheet. However, two days later the FDIC, the regulator of American Bank Deposits, declared that the SVB had failed.
The FDIC on Friday took over Silicon Valley Bank’s $175 billion in customer deposits. Among these customers deposits of $250,000 were insured by the regulator. Though many questions arise here – the first question which pops up in everyone’s mind is how SVB got into this position.
How Silicon Valley Bank got into this Position?
Over the past Five Years, the SVB boomed in terms of its deposits as its clients flushed money into the Bank to store rather than to borrow. By the end of 2021, the SVB’s deposit has increased to $ 189 billion from $ 44 billion in 2017; whereas, the loan has only increased to $66 bn from $23bn. So far so good.
SVB didn’t come to this position simply just by some wrong tech schemes or gambling on cryptocurrencies or lending to some risky start-ups. But, they got to this position by some number of bad decisions since 2021.
Normally, Banks earn money on the spread (i.e. interest rate paid on deposits (mostly nothing), and the rate they paid by borrowers). Since SVB was having a far larger deposit than a loan book there is a problem now. SVB had to purchase other additional interest-bearing assets. The bank had made $128 billion of investments, by the end of 2021, mostly in form of mortgage bonds and Treasuries.
In 2021, interest rates were near zero, the stock market roared and naturally, money flooded into the tech sector. This allowed many start-ups to park their money at SVB. Since there are huge sums parked in the SVB, it decided to invest that money including long-term bonds. Till last year, it looked relatively safe.
But, last year it became riskier as the interest rate started to increase and the Bonds are losing their value. During the end of last year and this year, investments in tech companies started to decline. This made start-ups pull their cash out of the banks to meet their expenses. As the interest rates were increasing the venture-capital fund started drying up and the Deposits fell from $189 billion in 2021 to $173 billion by the end of 2022.
To pay the demand for these payments, the SVB sold their bonds at a loss and started looking for fresh capital to meet its capital obligations. SVB met a loss of $1.8 billion by selling it at lower prices. This created a big gap to fill in the balance sheet of SVB. To plug this hole, the SVB tried to raise Capital. Based on the value at cost at the end of last year, the bank had held around $91 billion of investments at the time of the collapse.
Lessons from the Silicon Valley Bank’s Failure
There are many lessons to be learnt from Silicon Valley Bank’s failure. But the moral of the Story is a Bank should never invest their deposits in long-term bonds, especially one which has many clients who are tech-based (start-ups included). As these long-term bonds lose their value while interest rates rise and they are sensitive to interest rates.
Due to such a big bank failure – will anyone trust Silicon Valley Bank (SVB) or any bank which takes over/acquire it? Banking failure is not uncommon in US history, but the largest bank failure since 2008 (financial crisis) and that too in an era where banking is technology based is something to worry or say ponder about.
The failure of Silicon Valley Bank may be due to their online clients. As SVB customers/depositors are mostly tech investors and start-up founders who normally scrutinize the bank’s health conditions and pay attention to the risks as well as the volatility of the Bank. These people would have discussed the same and raised a question about Bank’s insolvency on social platforms which would have made other depositors also panic. The panicked customers/ depositors made a bank run. Though these kinds of conditions/situations cannot be ruled out – the main reason is – the Bank’s lending to the nature of the industry it had chosen to serve.
On the10th March 2023, FDIC stepped in and took over Silicon Valley Bank – as it always does when Bank fails. The SVB customers who had $250,00 or less deposited will be able to access their money soon. If there is any luck any big bank can take over SVB without any effort to make its larger depositors whole and control the damage by stopping the domino effect. This means it’s only simple orderly bank failure where there are no taxpayer bailouts as well as large/ huge start-up failures. This shows how the regulation works.
Our Perspective
In the first place, the Federal Reserve’s role of supervising the bank (or as a regulator) failed to do its job. Secondly, Congress increased the insurance threshold 2018 from $50 billion to $250 billion in 2018. Accordingly, the Dodd-Frank law (which was enacted in 2010) has been amended where the strict rule of undergoing “stress tests” – meant to gauge their capability of withstanding economic downturn – for small and mid-size banks is no longer required. There were also some warnings against this decision stating that policymakers are inviting another banking crisis.
As Paul Krugman Rightly said in his Opinion that “If I were a policymaker, I’d be reluctant to let S.V.B. fail, merely because while it probably wouldn’t have caused a wider crisis, one can’t be completely certain and the risks of erring in doing too much were far smaller than the risks of doing too little.”
Although the collapse of Silicon Valley Bank is concerning, the FDIC’s takeover demonstrates that the regulatory system is functioning effectively. If any big bank acquires SVB without any effort to make its larger depositors – as SVB itself is a bank with larger customers; then it can stop the domino effect. If this happened then SVB failure is only simple orderly bank failure where there are no taxpayer bailouts as well as large/ huge start-up failures. This shows how the regulation works.
We need to understand that any bank failure will send the wrong signal to the economy as a whole. Policymakers should be careful about what signals they send to the economy so that the economy is not severely affected. The financial stability of the economy completely depends on regulators and the Government. Therefore, policymakers should pave the way more carefully to avoid future pitfalls or crises.
FAQs
What happened to Silicon Valley Bank?
Silicon Valley Bank collapsed on March 10, 2023, becoming the second-largest bank failure in US history & the largest since the 2008 financial crisis. The Federal Deposit Insurance Company (FDIC) took over the bank, which had about $200 billion in assets.
Why did Silicon Valley Bank fail?
Silicon Valley Bank’s financial position had been deteriorating for years due to a series of bad decisions. Although the bank had many deposits, it had a smaller loan book, leading to a problem in earning money on the spread. To compensate, the bank made $128 billion of investments, mostly in the form of mortgage bonds & Treasuries. However, as interest rates increased & investments in tech companies declined, the bank was forced to sell these bonds at a loss, creating a significant gap in its balance sheet.
How did the FDIC respond to the collapse of Silicon Valley Bank?
The FDIC took over the $175 billion in customer deposits held by Silicon Valley Bank. Deposits up to $250,000 were insured by the regulator. The FDIC’s takeover prevented a domino effect that could have affected taxpayers & start-ups alike.
What lessons can be learned from the collapse of Silicon Valley Bank?
The collapse of Silicon Valley Bank demonstrates the importance of regulatory oversight & the need for banks to avoid investing their deposits in long-term bonds, especially when their clients are tech-based. The role of the Federal Reserve in ensuring that banks do not take unnecessary risks with their clients’ money is also highlighted.