The technology industry confronts a new hurdle as Silicon Valley Bank (SVB), its trusted specialized bank, crumbles following a “Bank Run.” It occurs when many depositors simultaneously approach a bank to withdraw their money. The reason for such simultaneous withdrawal could be their belief that the bank may become insolvent. This can cause the bank to collapse due to insufficient funds to issue the requested withdrawals.
SVB was the sixteenth largest commercial bank in the US. It is not the first time that such a large bank failed in the US.
A similar collapse happened in 2008 of the Washington Mutual (WaMu) Bank. It was a large US savings and loan bank. The bank collapsed due to bad loans and investments in the subprime mortgage market. It was the largest bank failure in US history at that time. Later on, WaMu’s assets were acquired by JPMorgan Chase.
To safeguard customer deposits, the U.S. government intervened. HSBC Bank is likely to acquire the U.K. division of Silicon Valley Bank (SVB).
In this article, we’ll delve into what caused the downfall of SVB and how this could impact tech businesses and startups globally. We will also look at how deeply is India affected by the SVB issue.
About Silicon Valley Bank (SVB)
Silicon Valley Bank (SVB) was established in 1983 and was among the 16 largest banks in the United States. The bank focused on providing banking and financing services to startup firms that were backed by venture capital. The companies that it did business with were primarily technology companies.
Headquartered in Silicon Valley, California, SVB’s assets amounted to $209 billion as of the end of 2022, as reported by FDIC. The bank specialized in the tech industry. It was a vital financial institution for numerous technology startups and venture capital firms. They relied on SVB’s support for financing and the growth of their businesses.
Collaboration: SVB & The Tech Companies
Almost half of all US venture-backed tech and healthcare companies & startups were financed by SVB. The bank was very supportive of the tech startup firms that other banks may have considered too risky. This is what made SVB a darling of tech startups.
In 2020, the pandemic fueled a robust market for technology companies. Consumers shifted their spending toward digital services and electronics, it was a golden period for tech companies. During the covid phase, these tech firms have significant cash-inflows. SVB helped these businesses to park their excess cash with it as deposits.
The bank in turn invested a significant portion of these deposits. It is standard practice for any bank to use the deposits of its customers to issue loans or buy investments.
The Reason: Why SVB Collapsed?
There were four cascading and interrelated reasons that led Silicon Valley Bank (SVB) to “Bank Run” and eventually its collapse:
#1. Higher Inflation & Interest Rates
- Inflation & Interest Rate Hikes: High inflationary concerns forced the Fed to raise interest rates. In the US, between 2020 and 2022, the interest rates were close to zero. The government kept rates low to fuel demand during the pandemic phase. But such low-interest rates led to high inflation. Hence, interest rate hikes became inevitable to reduce the supply of easy money in the economy. But higher interest rates can also be a double whammy.
- Money Scarcity for Banks: When interest rates are high, it becomes more expensive for banks like SVB to borrow money from the Feds. This reduces their available funds for lending. When lending reduces, people start withdrawing their deposits. When a lot of people do it, it can lead to a bank-run scenario. Decreased loan disbursements also affect the bank’s profitability.
- Increased Cost for Banks: When inflation and interest rates are on the rise, people seek higher returns. They expect higher interest rates on their deposits. In such a situation, they tend to withdraw their deposits and make new ones at higher interest rates. Some can even withdraw their money altogether and invest it elsewhere in high-interest-yielding instruments. When a lot of people start to withdraw funds simultaneously, it can lead to a bank run.
The combination of decreasing profitability and high cost is a dangerous situation for a bank. It is especially critical for banks like SVB whose depositors are mainly startups.
These companies will continue to keep their deposits in the bank till the bank can continue financing their working capital and Capex needs. Banks like SVB could do it between 2020-2022 because they were getting funds from the Feds at almost zero interest rate levels.
But as financing from SVB became difficult, these new-age companies started withdrawing their deposits.
#2. SVB Selling Bonds and Stocks
- Bonds: The problem for Silicon Valley Bank (SVB) was multiple withdrawals from its depositors and a lack of funds from the Feds. To manage these bulk withdrawals, SVB decided to source funds from their bond investments in US Treasuries. The decision to sell bonds was not only driven by the need to fund the withdrawals, there was another reason. The average yield of the bond portfolio of the SVB was about 1.79%. The yield of the current 10-Year bond was about 3.9%. As interest rates of already listed bonds were low, their value was also falling. To prevent the loss due to falling value, SVB decided to sell the bonds even at a loss.
- Stocks: To take care of the funding requirements, the bank decided to sell its $2.25 Billion worth of shares. As a result, between the 8th and 9th of March-2023, the share price of SVB nosedived by 60%.
The majority of Silicon Valley Bank’s (SVB) investments were parked in long-term bonds. Only a small portion was parked in short-term bonds. They did it to earn higher yields on their investments. When interest rates rise, the value of long-term bonds is most affected, forcing the bank to sell them at a loss. Hence, the poor diversification policy of SVB also contributed to the bank’s collapse.
These two desperate actions further triggered SVB’s Bank run scenario. The depositors thought that the Silicon Valley Bank (SVB) Collapse was imminent. Even some venture capital funds advised their clients to withdraw funds parked in SVB banks. It further triggered the bank run.
#3. Typical Depositor Base
The Silicon Valley Bank was most impacted in this case because most of its deposits were from the technology sector and from the startup space. Presently, the whole tech sector is facing problems due to revenue losses, job losses, etc. Hence, when SVB could not fund its Capex and working capital needs, they straightaway went for their deposits. The typical customer base also contributed to the Silicon Valley Bank (SVB) collapse.
#4. Deposits Greater than $250,000 USD
As per norms, all deposits of $250,000 or less are covered under insurance. But the Silicon Valley Bank (SVB) collapsed because almost 90% of all their deposits were greater than $250,000.
These deposits were of Tech Startups that have raised huge amounts of money from their investors. As a result, their deposits were running into millions of dollars.
These startups were keeping all deposits in SVB as it was their way to fund their working capital, expenses, payrolls, and bills.
When these tech startups heard the news of Silicon Valley Bank (SVB) collapse, they panicked and started withdrawing their funds. As most of their parked money was invested in long-term treasury bonds, the bank could not honor their withdrawal requests, leading to the Bank Run.
Silicon Valley Bank (SVB) Collapse is a one-bank problem?
No, solvency issues are faced by other US banks as well.
Credit Suisse agreed to be bought out by UBS in a government-brokered deal worth $3.25 billion on March 19. New York Community Bank also acquired a significant portion of Signature Bank in a $2.7 billion deal.
Moody’s Investor Service placed six regional banks under review for credit rating downgrades. These banks include Comerica Bank, First Republic Bank, Intrust Financial, UMB Financial, Western Alliance Bancorporation, and Zions Corp. These banks faced high unrealized losses and large amounts of deposits not covered by the FDIC.
Most of these banks had their own set of unique problems, but the present crisis was triggered by the increasing interest rates regime.
Future of Silicon Valley Bank (SVB)
The US government is not bailing out SVB. HSBC Bank is likely to acquire the U.K. division of SVB. But what happens to the US division? Mostly, it looks like that, it will have to go through the normal solvency proceedings. It means, in the future, there might not be any Silicon Vally Bank in the US. If the buyer of SVB decides to bring it back to life, they can, but till then the bank stays collapsed and un-operational.
So what happens to the stakeholders of SVB? Some are protected by FDIC and some will have to bear the losses.
- Depositors: Like India has Deposit Insurance And Credit Guarantee Corporation (DICGC), the US has FDIC. The FDIC formed an institution called the Deposit Insurance National Bank of Santa Clara (DINB). This institution will consolidate all insured and uninsured deposits into one institution. All deposits of SVB were transferred to the DINB. The insured deposits up to $250,000, were immediately made accessible to their depositors. DINB also confirmed that the uninsured deposits will also be made available to all deposits after FDIC sells the SVB’s assets.
- Shareholders: The shareholders of SVB are not protected by FDIC. They will have to face the consequences of the solvency proceedings.
It looks like, there will be no SVB in times to come. But at least the depositors have found protection from the US government through FDIC.
What Lessons We Can Learn From The SVB Saga?
First, it is essential for companies to diversify their investments. Like SVB, if most of the money is tied to only one type of investment, it is a recipe for future problems. You can see, the idea of overexposure to even the safest of securities like US Treasuries can go south. So, diversification of the investment portfolio is an uncompromisable requirement.
Second, it is also essential for governments to keep interest rate volatility within limits. They cannot focus only on inflation and raise or lower the interest rates within a short span of time. As in this case, gradual but continued rate hikes lead to a bank’s failure and depositors’ anxiety.
Third, as an investor, we must realize that even the safest of business models (Banking) can fail in the strongest of countries. So, no matter how lucrative a stock may appear, never overinvest in one. Keeping the maximum exposure to a single stock below 3% of the total equity portfolio size is a good idea.
Fourth, as an investor, when we do a liquidity analysis of companies, we safely assume “cash equivalents” as cash. For example, investments in government bonds are assumed as cash. But if the money is tied to long-term bonds, this money is not as liquid as we assume. In the case of rising interest rate scenarios, these long-term G-secs become almost illiquid. Selling them in such times will only come at a loss.
Impact of Silicon Valley Bank (SVB) Collapse on India
According to reports in Indian newspapers, Indian startups had about $1 billion worth of deposits in the Silicon Valley bank. After FDIC constituted the Deposit Insurance National Bank of Santa Clara (DINB), about $250-$300 million were withdrawn by these companies.
The Indian banking industry is unlikely to be affected by the SVB aftermath.
Indian stock market may see knee-jerk reactions as some investors might correlate it with the 2008-09 market crash. There could be some short selling, but it will be only temporary. Especially after seeing the actions taken by the FDIC on the SVB case, it looks less likely that the stock market will be affected much. Though this incident has given us double confirmation that the tech industry is in crisis.
So people who are holding tech stocks might have to see more lateral or downside movements in their stock price.
Have a happy investing.
I love reading your articles. They are very logical, breaking down complex topics into simple analytical and educational tutorials!!
Very comprehensive report. Gives a deep analysis of the failure. Lesson don’t keep aa eggs in one basket. Increasing interest rate by federal government -was it a wise decision ?.