The Collapse of Silicon Valley Bank (2023)
In this article, Mirabelle DING (Telfer School of Management, Bachelor in Finance, 2015-2019) analyzes the collapse of Silicon Valley Bank (SVB).
On March 10th 2023, Silicon Valley Bank, the primary financial institution for the US technology sector, was shut down by California and Federal regulators due to illiquidity and insolvency concerns after depositors withdrew $42 billion within a single day, marking the second largest bank failure in the United States history.
Background of SVB
Silicon Valley Bank (SVB) was founded in 1983 in the Bay Area with its mission to provide banking services to venture capital-backed startups that would have been considered high risk by traditional banks. As a result of its pioneering vision, SVB had established a notable reputation among the tech community, and was providing financing services to nearly half of the venture-backed technology and life science companies in the United States. SVB was ranked the 16th largest bank in the United States with total assets of $209 billion and was recognized as one of America’s Best Banks by Forbes for five consecutive years before its defunction.
Logo of Silicon Valley Bank.
Source: Silicon Valley Bank.
The Solvency-Liquidity Problem
In 2020, the Federal Reserve cut the Federal Funds rate down to a range of 0% to 0.25% and implemented an unlimited quantitative easing policy in response to the impact of the Covid-19 pandemic, which led to a substantial increase in the financial market’s liquidity and the price of financial assets. The deposit base of SVB also experienced a skyrocket from $60 billion to an impressive $190 billion by the end of 2021. With little demand for loans from its clients, SVB allocated almost three quarters of the incremental deposits in long-maturity US Treasury bonds and mortgage-back securities purchases in order to gain capitalize on the interest rate spread. As a result, SVB exposed itself to greater interest rate and market risks.
Starting from March 2022, the Federal Reserve started to raise the Funds rate to counter inflation. The benchmark rate hiked to 4.5%-4.75% within 12 months, causing a plunge in the financial market liquidity and a severe inverted yield curve of long-term bonds and securities.
As interest rates rose, SVB started suffering deep unrealized losses on much of its securities portfolio, amounting to more than $2 billion by the end of 2022.
Furthermore, due to the declining inflow of venture capital funding, many tech start-ups resorted to withdrawing from SVB to support their daily operations. From March to December, the deposits of SVB shrank rapidly from $200 billion to $175 billion. Since SVB did not protect their liabilities with short term investments for quick liquidations, they had to start selling their bonds at a significant loss and relied heavily on short term loans from Federal Home Loan Banks to accommodate these large withdrawals, totaling $15 billion by the end of 2022.
“The Social Media Bank Run”
On March 8th 2023, SVB announced a $1.8 billion loss on its investment portfolio, alongside a plan to raise $2.25 billion. Consequently, Moody’s downgraded the bank’s credit rating, and the stock price of SVB’s parent company, SVB Financial Group, crashed at the next market opening. Prominent entrepreneurs raised concerns about SVB’s financial situation on social media, which went viral and amplified the panic among the bank’s clients. Depositors rushed to withdraw from their SVB account, culminating a total amount of $42 billion in attempted withdraws within 24 hours. SVB was on the verge of collapse as they could not generate enough cash to meet the escalating need for withdrawals.
On March 10th 2023, the Federal Deposit Insurance Corporation, which protects the stability of the financial system, took over Silicon Valley Bank in an effort to protect depositors. Unlike personal banking, most clients held more the $250,000 FDIC insured limit in their accounts, putting them at the risk of losing a portion or all of their deposits that exceeded the threshold. To restrain the fear of financial contagion, the Federal Reserve later implemented emergency measures, ensuring that all deposits at SVB will be guaranteed, even for the amount above the $250,000 limit.
Later, the Federal government announced an emergency lending programing to allow distressed banks to borrow from the Federal Reserve as a contingency liquidity plan to cover their withdrawal needs and to restore public confidence in the financial system.
Conclusion
The collapse of SVB reflected an inadequacy in its risk management and strategy, which could have been avoided through regular review and valuation of their investment portfolio, avoidance of concentrating assets in long-term maturities, possession of sufficient liquid assets, and hedging strategies against rising interest rate. This demonstrates the importance for businesses and organizations to properly and promptly manage their financial risk to prevent or mitigate situations that may lead to financial distress.
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Useful resources
Apricitas Economics The Death of Silicon Valley Bank
The Federal Reserve Re: Review of the Federal Reserve’s Supervision and Regulation of Silicon Valley Bank
About the author
The article was written in May 2023 by Mirabelle DING (Telfer School of Management, Bachelor in Finance, 2015-2019).
