The United States is reeling from the largest bank failure since the financial crisis of 2008. The Silicon Valley Bank (SVB) has collapsed, leaving many wondering how this could have happened and what the ramifications will be. In this article, we will delve into the causes of this catastrophic event and explore the potential consequences for the financial industry.
Silicon Valley Bank (SVB)
Silicon Valley Bank, which started in 1983 and used to be one of America’s top 20 commercial banks, provided banking services to nearly half of all US venture-backed technology and life science companies. It even had operations in multiple countries such as Canada, China, Denmark, Germany, Ireland, Israel, Sweden, and the United Kingdom.
Thanks to the recent boom in the tech industry and the increase in demand for digital services, Silicon Valley Bank saw tremendous growth. The bank’s assets, which include loans, more than tripled from $71 billion in 2019 to a whopping $220 billion in March 2022. Deposits also soared from $62 billion to $198 billion over that same period, as thousands of tech startups entrusted their cash with the Silicon Valley Bank. As a result, the bank’s global headcount increased by over two times its original size.
However, after all this economic prosperity, last week Friday (10March) marked the collapse of the Silicon Valley Bank. Characterised by incredible speed, investors and experts are currently concerned that a broader banking meltdown in the form of a “slow-rolling crisis” in the US financial system might be the next step.
Inside the Collapse and Bank Run
Silicon Valley Bank’s collapse came as a shock to many, as customers quickly withdrew their deposits from the lender within a mere 48-hour window. It was a classic run on the bank that signalled the end of the Silicon Valley Bank.
However, the reasons behind SVB’s downfall extend beyond the recent chaotic events. Like many other banks, SVB invested billions of dollars into US government bonds during a time of nearly zero interest rates. This investment strategy seemed like a safe bet at the time, but it quickly proved to be unsustainable when the Federal Reserve increased interest rates aggressively to curb inflation.
The spike in interest rates had a significant impact on SVB’s bond portfolio, as bond prices tend to decrease as interest rates increase. According to Reuters, the bank’s bond portfolio only yielded an average return of 1.79% last week, which was significantly lower than the 10-year Treasury yield of approximately 3.9%.
Furthermore, the Fed’s decision to increase interest rates also led to an uptick in borrowing costs, causing tech startups to channel more funds towards paying off their debt. Additionally, these companies were having difficulty raising new venture capital funding, leading them to withdraw their deposits held by SVB to fund their expansion and operations. All of these factors ultimately contributed to the bank’s collapse.
Looking back, the beginning of last week was marked by a confident speech from Silicon Valley Bank’s chief executive, Gregory Becker, to an audience of investors, analysts, and technology executives. He proudly highlighted the bank’s position in the tech industry.
However, only a few days later, Moody’s, a rating agency, contacted Becker to inform him that the bank’s financial health was at risk, and its bonds had the potential to become worthless. This news came as a shock to Becker and his team, and they realized that they needed to raise cash immediately. Unfortunately, it was too little too late.
Just one day after the phone call with Moody’s, on Thursday, chaos erupted within Silicon Valley Bank, and the bank announced a loss of $1.8 billion. While the bank had established a plan to raise $2.23 billion in the capital, the news had already spread to investors and depositors, leading to a massive panic. Stocks plummeted by approximately 60%, and $40 billion was withdrawn from Silicon Valley Bank, causing widespread panic and financial instability.
As Friday morning dawned, trading in SVB shares came to an abrupt halt, signalling a grim turn of events. The bank had already given up on trying to raise capital or find a buyer to salvage the situation. Things took a turn for the worse when California regulators stepped in and decided to shut down the bank, placing it in receivership under the Federal Deposit Insurance Corporation (FDIC).
This move typically implies that the bank’s assets would be liquidated to repay depositors and creditors, adding to the anxiety of those affected by the bank’s collapse. It was an unexpected end to a bank that had been such an integral part of the tech industry for so many years.
US regulators said Sunday that SVB customers’ deposits would be guaranteed, in an attempt to prevent further bank runs and assist the tech companies to fund their operations and staff. In this light, investors in bonds and stocks will not be reimbursed for their losses.
Who to Blame?
Farrel in the Nytimes argues that “the tale of Silicon Valley Bank is one of ambition and management mistakes” hinting at the tunnel vision of the chief executive. While innovation and the future were the main aspects of his vision, risk management and ensuring financial stability was not top priority. Caught in the “flat-flooded” changing economic environment, SVB waited until the last minute to avert its fate.
Danny Moses, an investor at Moses Ventures and the predictor of the 2008 financial crisis in his book and movie “The Big Short”, agrees that the collapse of SVB is not necessarily greed but instead bad risk management: “It was complete and utter bad risk management on the part of SVB”.
To showcase the lack of risk management, anxiety and panic played a pressing role in the downfall of the bank. To exemplify, the Thursday of the call by Moody’s, Becker joined a webinar with a large audience including investors and lawyers. He reassured them that the bank had adequate liquidity. However, according to the people present in the call, towards the end of the meeting, he added a caveat: if people began to spread rumours about SVB being in trouble, it could pose a significant challenge for the bank. David Selinger, chief executive of the security firm Deep Sentinel, had been a customer of SVB for twenty years and argues that this “prisoner dilemma” resulted in the firm pulling all money out of the bank: “As much love and desire we have for SVB, fear came first.”
According to Valdis Dombrovskis, the Executive Vice President of the European Commission, the EU seems to be distancing itself from the SVB debacle by suggesting that it’s not their problem. Dombrovskis has stated that the EU has limited exposure to Silicon Valley Bank and that a spillover effect is unlikely. Although the collapse of SVB caused a 5.84 percent drop in EU bank stocks on Monday, they rebounded on Tuesday, with a 2.46 percent increase in closing prices. The EU maintains close contact with the corresponding authorities.
Justifying this view, Silicon Valley Bank’s business model was heavily reliant on serving the needs of tech startups in the region, which made it vulnerable to the economic struggles of the tech sector. As the pandemic tightened funding conditions for these companies, they began to withdraw deposits and burn through cash at an alarming rate, forcing the bank to sell off securities at a loss and exacerbating concerns about its financial health.
Compounding the situation, many of SVB’s customers had deposits that exceeded the key protection threshold, which also incentified the bank run. However, it’s worth noting that SVB’s impact on the global banking system is relatively small. It was the 16th largest bank in the US and would have ranked around 43rd in the EU’s less consolidated market, similar to Belgium’s Belfius.
Moreover, SVB only had a smaller branch in Germany, and while its UK subsidiary had failed and been bought by HSBC for an iconic $1 to safeguard the deposits of “thousands of British tech companies that hold money at the lender”, EU banks had limited direct exposure and potential losses related to the US bank’s failure, minimizing the risks of direct spillover.
Upcoming Bank Crisis?
Whilst the EU does not prospect a banking crisis, many analysts agree that the US and European banks have a stronger financial buffer than during the 2008 financial crisis. These experts also argue that SVB had heavy exposure to the tech sector and that the rising interest rates hit this sector especially hard. As M&G Investments research analysts David Covey, Adrian Cighi, and Jaimin Shah noted in a blog post, SVB and other niche players like Signature are unique in the broader banking world, making it unlikely that their failure will create material problems for larger, diversified banks in the US or Europe.
Opposing this perspective, the CEO of BlackRock, Larry Fink, warns that the collapse may indicate a “slow-rolling crisis”. As inflation persists and interest rates continue to rise, other banks need to survive identical pressing factors resulting in the SVB’s collapse. Fink mentions that this is the price to be paid after the Federal Reserve started to “aggressively” raise the interest rates. With the fastest price hikes since the 1980s, it is no wonder that the financial system is showing cracks. As of now, it is too early to predict the contagiousness of the collapse yet markets remain on their edge.
The current instability in the European financial market could pose a significant risk to global market stability. On Wednesday (15 March), Credit Suisse, a global investment bank headquartered in Switzerland, saw its stocks plummet by over 21% due to the SVB collapse, and its top shareholder, the Saudi National Bank, not providing further financial assistance. Economist Nouriel Roubini warned that if Credit Suisse were to collapse, it could trigger a “Lehman moment,” similar to the collapse of Lehman Brothers in 2007 which marked the beginning of the global financial crisis.
To summarize, experts and authorities showcase the unpredictability of the risks the SVB collapse has on the European and American financial sectors. Whereas the EU pleads that a spillover effect will not happen due to the minimal impact on the EU market, experts in the field fear that the, mainly American, persisting high-interest rates and inflation might derail the financial system and drag evident players with them into this downfall. In the worse scenario, a “Lehman moment” might occur which indicates the beginning of the 2008 global financial crisis. Following the plunge of Credit Suisse’s stocks by more than 20% this Wednesday, concerns for another financial crisis are sparked.
Photo by Mariia Shalabaieva on Unsplash