Unpacking the Silicon Valley Bank Collapse: Causes and Consequences

Contents

Introduction

In March 2023, the California Department of Financial Protection and Innovation shut down Silicon Valley Bank, a financial institution headquartered in Santa Clara, California. The regulator cited substantial losses in its investments and a significant amount of money withdrawn by its depositors as the reason for its action.

It is essential to note that bank failures are not uncommon. However, the SVB’s failure was surprising because the bank’s financial statements had not shown any red flags, making it challenging for regulators and customers to predict the collapse.

During a recent press conference, United States Federal Reserve Chairman Jerome Powell admitted that he and his regulatory team were taken aback by the sudden collapse of Silicon Valley Bank (SVB) earlier this month, despite being under their supervision. The bank’s failure triggered a panic about a potential banking crisis, disrupting global financial markets.

Powell expressed his surprise at the turn of events, stating that the question on their minds during that weekend of the collapse was, “How did this happen?” Powell quickly emphasized the need for a review to investigate the matter.

According to reports, examiners from the Federal Reserve’s San Francisco branch had previously raised concerns about SVB, stating that the bank relied too much on uninsured deposits and Treasury assets that had declined in value over the preceding year. Despite this, the regulators were unable to prevent the bank’s collapse.

Although similar bank failures have happened in the past – over 550 banks have been shut down between 2001 and the beginning of 2023 – SVB’s case stands out. This particular bank failure occurred during a time when many Americans were anticipating an economic downturn. It is also the most significant bank failure since Washington Mutual’s collapse during the 2008 financial crisis.

This article comprehensively examines the factors that led to Silicon Valley Bank collapse, the bank’s history, and the consequences of its failure for the financial sector.

How Silicon Valley Bank Became Popular

Silicon Valley Bank (SVB) was a commercial bank that was founded in Santa Clara, California, in 1983. The tech industry in Silicon Valley was booming at the time, so the bank was established to provide those new tech companies with banking services tailored for them.

In its early years, SVB focused exclusively on providing loans to emerging technology companies (startups). Since they were viewed as high-risk investments, many of these new firms could not obtain conventional bank loans. However, the founders of SVB saw an opportunity to give many of these businesses the funding they required to succeed after realizing they had the potential for rapid expansion and success.

Over time, as the tech industry grew, Silicon Valley Bank expanded its range of services to include a variety of financial products such as cash management, foreign exchange, and investment banking. The bank’s reputation as a top banking services provider in the tech field grew as well, leading to increased customer demand from related industries such as life sciences and healthcare.

Silicon Valley Bank was among the first banks to offer online banking services to their customers. They did so as early as the 1990s. The bank also increased the scope of its activities by opening branches in important global technological hotspots, including China, Israel, and the U.K.

Silicon Valley Bank thrived throughout the 2000s. Even during the early 2000s dot-com meltdown, the bank was able to weather the storm because of its focus on the technology sector. It has since established itself as a top supplier of financial services to startups and fast-growing businesses.

Silicon Valley Bank kept introducing new concepts and increasing its product offerings. The bank’s first venture capital fund, SVB Capital, started making investments in technology startups in 2011. The bank’s lending services also included different debt and equity funding alternatives for technology companies at various stages of growth.

Why Silicon Valley Bank Collapsed

This sudden bankruptcy of the $212 billion tech lender cannot be attributed to a single reason. Experts have identified several key factors that led to the failure of SVB, including:

The Bank’s Bad Management Practices

According to reports, the bank didn’t have a Chief Risk Officer (CRO) for a portion of 2022, a circumstance that the Federal Reserve is currently reviewing. The previous CRO of SVB, Laura Izurieta, officially stepped down from her role in April 2022 but left the company in October 2022.

SVB Shareholders reportedly filed lawsuits against the bank’s top executives, accusing them of failing to disclose critical information on the bank’s business model and how it was susceptible to a bank run. The board’s risk committee had been meeting frequently before the bank collapsed.

SVB has also been accused of putting social justice ahead of sound financial management. According to James Comer, the Chairman of the Republican oversight committee in the House, SVB was “one of the most woke banks.” This claim, however, is based on a bigger debate about ESG or investing based on environmental, corporate, and social governance.

However, the bank’s Diversity, Equity, and Inclusion (DEI) policies and the fact that it made loans to environmental and community projects did not play a major role in its demise.

Increased Interest Rates

The decline in the price of technology stocks over the past year and the Federal Reserve’s plans to raise interest rates quickly to fight inflation were both very bad for SVB.

In the last couple of years, the bank bought bonds worth billions of dollars using customer deposits, as a conventional bank would. Although these investments were usually safe, they lost value because they had lower interest rates than a similar bond would have had if it had been issued now, when interest rates are higher.

Most of the time, this is not always a problem because banks keep things for a long time—until they must sell them in an emergency. But this wasn’t the case for SVB because of their next step.

The Bank Sold Its Bond Portfolio at a Loss

Silicon Valley Bank had invested 43% of its assets in held-to-maturity securities, mainly bonds with a fixed coupon payout. While considered a low-risk investment, these securities can pose a problem if the bank needs to sell them quickly for cash.

Interest rates steadily rose in 2022, resulting in a significant decline in bond values. By the year-end, Silicon Valley Bank had incurred an unrealized loss of $15 billion from its held-to-maturity products. In an attempt to increase its capital, the bank was compelled to sell these debt instruments at a loss, triggering a sudden liquidity crisis. This loss was publicly disclosed as the bank sought to sell its stock.

Customers soon discovered a significant discrepancy between their balance sheets and deposits. Consequently, they tried to withdraw their funds from the bank quickly, leading to a bank run.

Timeline of SVB Collapse

Silicon Valley Bank abruptly failed within a few days. Here’s a breakdown of the timeline of the events that led to the collapse:

March 8

SVB announced that it had lost $1.8 billion on its bond portfolio and would sell common and preferred stocks to raise $2.25 billion. After this announcement, Moody’s lowered its ratings for Silicon Valley Bank as an issuer and for long-term local currency bank deposits.

March 9

The stock price of Silicon Valley Bank’s parent company, SVB Financial Group, fell when the market opened. Several large banks’ stock prices also fell. Several SVB clients began withdrawing their funds, with a total of $42 billion in attempted withdrawals.

March 10

SVB Financial Group stock trading was suspended. Federal regulators declared they would take over the bank before it could begin operations for the day. Deposits were transferred to a bridge bank established and run by the FDIC after regulators failed to locate a buyer for the bank, with the assurance that protected deposits would be accessible by Monday, March 13.

March 12

In response to the failure of Silicon Valley Bank, federal regulators announced emergency measures that allow customers to get back all of their money, even if it wasn’t insured.

March 17

SVB Financial Group, the parent company of Silicon Valley Bank, filed for bankruptcy.

Potential Impacts of SVB’s Collapse on Small Businesses and the Financial Sector

The failure of SVB sent shockwaves through the financial world and caused panic among customers and businesses. SVB’s customers were concerned about being unable to pay their employees, which may have hurt the economy. However, panic has decreased noticeably since the U.S. government announced it would guarantee the bank’s clients’ money. Following the announcement, stocks, and financial futures have climbed by 1% to 2%.

However, the bigger concerns now are other banks’ excessive investments in declining bond values and rising interest rates. To help banks and credit unions meet customer demand, the Federal Reserve has established a new program called the Bank Term Funding Program. This program offers loans secured by mortgage-backed securities and U.S. government securities, preventing banks from losing money when they sell long-term government assets.

The technology industry is currently the biggest worry, having been hurt by the recession. As a result, larger I.T. companies have had to lay off workers. Also, funding challenges for startups may arise due to management teams at other banks being reluctant to take investment risks.

Will SVB Crash Lead to a Banking Crisis?

There are already some indications of stress in other banks. After the shares of PacWest Bancorp (PACW) and First Republic Bank (FRC) fell 52% and 65%, respectively, trading in those stocks was momentarily suspended. Also, shares of Charles Schwab (SCHW) were down 7% around 11.30 a.m. E.T. on Monday, March 13.

The benchmark Stoxx Europe 600 Banks index in Europe, which monitors 42 significant E.U. and U.K. banks, dropped 5.6% in morning trade, marking the largest decline since last March. The troubled Swiss banking behemoth Credit Suisse saw a 9% decline in its share price.

In addition, government bonds and other asset investments made by SVB and other financial institutions have experienced significant value declines. According to the FDIC, U.S. banks held $620 billion in unrealized losses( assets whose value has decreased but which have not yet been sold) by the end of 2022.

On Sunday, March 12, the Fed said it would give more money to qualified financial institutions to keep the next SVB from going bankrupt. This is a sign that regulators are worried about a bigger shakeup in the financial sector.

What Happens Next?

Currently, experts don’t foresee any issues that could spread to the broader financial industry. However, some volatility might cause temporary fluctuations, as demonstrated by the brief decline and subsequent recovery of the crypto market.

SVB distinguished itself by financing businesses primarily in the tech industry or supported by venture capital. It made remarkable strides in an economy that was severely impacted last year. However, if the funds deposited with SVB cannot be readily accessed, it could have economic ramifications, specifically for the U.S. tech startup sector.

SVB’s failure highlights the importance of financial management in both good and bad times. During a recession, companies need to be extra careful due to problems with the supply chain, higher interest rates, and difficulties in raising capital. However, at other times, companies must also be careful to hedge bets when they make them.

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