Why Silicon Valley Bank Failed
An simple explanation of the Silicon Valley Bank Collapse & the Government's Response
I’ve taken a while to write this article for various reasons. The most important reasons being that I wanted to take time to see how the Silicon Valley Bank (SVB) collapse played out, to collect my thoughts, and also the fact I’ve just been busy. Later this week I’ll write another article on my personal thoughts, but I want to provide context and not overwhelm you in one article.
How did Silicon Valley Bank Collapse?
I want to make this as short and simple as possible, because understanding the technical aspects of how SVB collapse is not the most important part of this story.
The simplest explanation is Silicon Valley Bank did a poor job of risk management. SVB received a huge influx of deposits during the early part of the pandemic (2020 to the end of 2021).1 So many deposits, that the bank had to figure out what to do with all that money. While much of this money was loaned out, they also took billions of depositors money and bought government bonds and mortgage backed securities. A very large number of these securities were 10 years in duration.
There were three problems with this decision. One, SVB did not hedge against these investments (we will get to this later). Typically, institutions will hedge against investments to protect them from losses. Two, Silicon Valley Bank largely serviced startups and venture capital firms. The problem here is that there was no diversity in their clientele. Due to the fastest federal funds rate increase in history (which is likely to continue) startup companies have had trouble raising money, and are burning through it very quickly. Therefore, tech companies were draining billions out of SVB’s deposits, and not putting any deposits in. Most banks have more diverse depositors and more diverse customers that they lend to. When all your clients are in one sector (technology), you are exposed on both sides; meaning your depositors are draining all their money and your loans aren’t being paid back. The third point is similar to the second in that startups do not typically have 10 year windows. Roughly 90% of startups fail, and many of those burn through all their cash faster than 10 years. They need their money back in a faster timeframe than 10 years. In sum, there was a duration mismatch.
The last part of this equation has to do with the fact that no bank has enough money to cover all their deposits. Though the percentage of deposits on hand vary by bank size, most banks likely do not have more than 20% of deposits on hand at one time, and that number is likely closer to 10% for smaller banks. That means if everyone ran to the bank and asked for their money, at most only 20% of that money is available.
With deposits flowing out like a running faucet, Silicon Valley Bank rushed to raise more cash. Think about it this way, SVB had thousands of papers saying they were owed billions of dollars, however they needed the actually money not just a paper saying they were owed money. They did this by selling those 10 year bonds and mortgage backed securities for cash. The issue is that the yields on these securities at the time of purchase (2020-2021) were under 2%. With the Fed raising rates at the fastest clip ever, those old securities were not worth as much as they were when they bought them. If Silicon Valley Bank held the securities until they matured (10 years) there would be no loss. But since you have to sell them earlier on the secondary market they were marked at a loss—more than 21 billion in losses to be specific. This scenario is why banks hedge these investments with shorter term securities to protect against these type of losses—which SVB did not do. Banks are allowed to not mark securities as losses until they sell them, so banks across the country are actually sitting on hundred of billions of unrealized losses right now (because they haven’t sold these securities yet), roughly 620 billion at the end of 2022.
Back to SVB though, they still needed more money. They announced this is a press release saying they needed more cash to cover a shortfall, and all the venture capitalists with money in the bank freaked out and voiced their concern on Twitter. What came next is the important part, large numbers of depositors at SVB started asking for their money back. Thanks to online banking, depositors around the world can transfer their money just by clicking on their phone. No need to run to the physical bank, you could be in Timbuktu and get your money out. SVB didn’t have the money however, and the bank collapsed.
Similarly, other precarious banks started to fail as well in a similar fashion including Signature Bank, marking the second and third largest bank failures in US history. Next is where things get interesting. the Federal Deposit and Insurance Corporation only covers deposits up to $250,000. More than 93% of SVB bank’s deposits were more than $250,000, and therefore uninsured—meaning less than 7% of all money deposited at SVB was promised to depositors.
The California government, Federal Reserve, and FDIC took over SVB once the bank failed on Friday March 10th, and searched for a larger bank to buy SVB and cover the deposits—no bank wanted to. By Sunday evening, the FDIC announced the creation of a new bank, the “National Bank of Santa Clara” to Protect Insured Depositors of Silicon Valley Bank. This announcement proclaimed the FDIC would cover all depositors of SVB no matter the amount, and would have their money available by Monday March 13th. Banks pay the FDIC to insure their money, so at present no taxpayer money has been used to cover these deposits. But in the case that too many people/corporations ask for their money back, the amount might exceed the FDIC’s insurance pool and dip into taxpayer money. While the FDIC’s actions were a huge move, the next part of this story is where it gets really interesting.
In an effort to protect all despitors (and all banks), on Monday March, 13th the Fed announced the:
“Bank Term Funding Program (BTFP), offering loans of up to one year in length to banks, savings associations, credit unions, and other eligible depository institutions pledging U.S. Treasuries, agency debt and mortgage-backed securities, and other qualifying assets as collateral. These assets will be valued at par. The BTFP will be an additional source of liquidity against high-quality securities, eliminating an institution's need to quickly sell those securities in times of stress.”
Long story short, the Fed announcement pledges to protects pretty much all poor risk management by banks by eliminating the potential losses from selling securities early and providing liquidity (the money to cover deposits) to (seemingly) all (FDIC) banks. Now this is really unprecedented, the Fed is now backstopping all banks for a year. This move made it much harder for any bank to fail in the same manner as SVB. To recap (starting from mid 2022) the Fed made it much more likely that banks would fail by increasing rates rapidly, (fast forward to the present) now they were making it much less likely banks would fail by creating this new BTFP.2 The combined effect of the FDIC and Fed announcements seemingly means all deposits in FDIC insured institutions are covered by the federal government, no matter what the amount.
The ultimate goal of the FDIC and Fed announcements were to protect all banks. The fear was that after two of the largest bank failures in US history, depositors across all banks would start asking for their money bank and a domino effect of bank failures would occur, leading to several or even dozens of additional bank failures. Over the next week (as of Friday March 17th) bank stocks prices and the broader stock market fell, but no additional banks failed (stock prices do not equal deposits they are totally separate things).3 First Republic Bank almost failed, however the largest banks in the world basically injected 30 billion into First Republic to save the bank—I guess the big banks found First Republic more appealing than SVB.
Over in Europe, there are now issues with Credit Suisse—however these issues are more about decades of mismanagement at Credit Suisse as opposed to SVB quick demise over the course of a week. Still, trouble at SVB likely caused institutions and individuals to worry about Credit Suisse. While Credit Suisse is largely unknown to most Americans, it is one of the more important investment banks on Wall Street and the world (I remember hearing about it often during my time on the Street), and also serves some of the wealthiest people on Earth thanks to its wealth management wing. The Swiss federal government announced $54 billion in funding to save Credit Suisse (see, the US isn’t the only country saving a bank), and UBS—the largest Swiss bank—is currently in negotiations to take over part or all of Credit Suisse.
Final Thoughts
The truth is, all banking is about trust. In a world where no bank holds all depositors money at one time, banks only exist because depositors believe they will have access to their money when they need it—even though realistically only 10-20% is of all depositors money is available at one time. If everyone at a bank runs to take out their money at once, the system fails. Therefore, these guarantees by the federal government (in both the US and Switzerland) are meant to reassure depositor’s trust and stop large numbers of people taking out their deposits at once. Without trust, all banks would fail.
Later this week, I plan to write my thoughts concerning the government’s intervention in financial markets.
Disclaimer: This is not professional and/or financial advice. This content is for informational purposes only. Before making any financial decisions you should do your own research, evaluate your financial situation, and/or consult a financial professional.
Is the pandemic over or? It’s been 3 years now.
By much less likely, I mean relative to the days before the BTFP was created.
However, a bank can sell shares for cash to raise money to cover deposits—something SVB tried to do but too little too late.