Founded in 1983, Silicon Valley Bank (SVB) became the go-to banking partner for tech startups, offering commercial banking, investment banking, and venture capital services, as well as private banking and wealth management services. As the startup ecosystem around Silicon Valley boomed, so did SVB, which banked with nearly 50% of US venture-backed technology and life science companies.
However, recent years have seen an abundance of capital and funding available to startups, resulting in more money to deposit than a need to borrow. As of December 31, 2022, SVB had $173.1 billion in deposits and only $74.3 billion in loans, with deposits having tripled in the last two years. Given that banks make money on the difference of the interest rate they pay to depositors versus the one they receive from borrowers, SVB needed to do something to close the gap. The common choice was to invest in long-term mortgage bonds and Treasuries.
However, the macro environment changed suddenly, causing two problems. Firstly, the end of abundant liquidity meant that startups needed to withdraw cash faster than anticipated, and corporate deposits are famously more volatile than retail ones. Deposits went down from $198 billion in March 2022 to $165 billion in February 2023. Secondly, the aggressive interest rate hikes of the Federal Reserve to combat inflation meant that the value of SVB purchased bonds at peak prices went abruptly down.
The result was that SVB was forced to sell the part of its portfolio that was liquid (available-for-sale) at a loss of $1.8 billion to raise cash. Unfortunately, the loss would bite directly into the bank’s capital ratio, meaning that SVB needed to raise capital on top to remain solvent. However, the attempt to raise capital was unsuccessful, prompting regulators to intervene.
The collapse of SVB is a classic example of banking asset-liability mismatch, as the entire banking concept is based on the assumption that depositors will not want to withdraw money at the same time. Central banks act as the lender of last resort to provide necessary liquidity in such situations.
Given the stakes for the tech ecosystem, as well as the wider financial system, regulators did not have much choice other than to intervene to avoid a spillover. The downfall of Silvergate Bank, a major crypto lender, and now of SVB, has proved that crypto, with its current set-up, is not immune to traditional finance market events.
While SVB is not comparable to Lehman Brothers, both in terms of the cause and the regulator’s reaction, it needs to be monitored with caution. It remains to be seen what the long-term impact of this collapse will be on the startup ecosystem and the wider financial system.
It’s easy to look back and wonder how Silicon Valley Bank (SVB) could have missed the warning signs that led to their collapse, particularly with the impact of the pandemic and the interest rate hikes from the Federal Reserve.
This is not a complicated calculation, you are leveraged 10:1 and your capital is based around long term treasuries with low yield. As interest rates rise, buyers of the bonds would want a discount to maintain a decent yield compared to the prevailing rates. That means you are selling bonds at a loss. At 10:1 leverage a 10% fall in the value of the bonds, wipes out the bank’s capital.
One would expect that the risk department would have been closely monitoring these factors and implement appropriate risk management strategies.
It’s possible that SVB’s focus on providing banking services for startups and tech companies caused them to overlook potential risks outside of their core business. However, given the magnitude of the impact, it’s hard to imagine that no one saw it coming.
The lesson here is that even the most successful and innovative banks can fall victim to a changing economic landscape. It’s crucial for banks to have effective risk management systems in place, including monitoring economic trends and developing contingency plans. Failure to do so can have severe consequences, not only for the bank but also for its clients and the wider financial system.