Silicon Valley Bank (SVB) was one of the best banks in the united states, and it had over 209 billion dollars in assets.
But it all went downhill when FDIC shut down SVB on March 10, 2023.
How come such a stable bank with a strong foundation abruptly collapsed and caused massive panic among people worldwide? In this article, we will discuss in detail the reasons that lead to the collapse of SVB.
Let’s get started.
Importance of Silicon Valley Bank to the Tech Sector
SVB was the institution to go to for Venture Capitalists and Tech Startups because they backed new businesses that other banks wouldn’t accept owing to higher risks. Many startups invest their monies received from investors in SVB.
Why does Silicon Valley Bank Collapse?
The reason for the downfall of the bank was due to various factors, such as a lack of portfolio diversification and a traditional bank run. This occurred when many customers withdrew their deposits concurrently, fearing that the bank would not remain solvent. A significant number of SVB’s depositors were startups who had deposited substantial amounts of cash from investors due to the high demand for tech during the pandemic.
Lack of Portfolio Diversification
Due to the Pandemic, many tech startups have started to bloom, and SVB has a sudden influx of cash. They decided to make a profit from the cash they held and invested around 80 billion in long-term bonds and agency mortgage-backed securities.
Later, the Feds decided to raise the interest rates, which led to the new bonds paying higher interest rates and making the long-term bond less attractive to investors.
Then, SVB’s bond portfolio started to decline, and they could have regained their money by holding the bonds to maturity, but they chose not to do so.
SVB operated without a chief risk officer for eight months, who was supposed to aid in rebalancing their portfolio in a higher interest rate environment. As a result of that, there was no expert to support the distressing situation.
Previously, Silicon Valley Bank made short-term loans. Instead of using short-term assets to cover their liabilities in 2021, they switched to long-term securities like treasuries to increase yield. Because they could not sell their assets without suffering a significant loss, they were insolvent for months.
As a result of economic reasons, venture capital began drying up, and many clients withdrew their money from their banks. Long-term investments prevented SVB from using available capital to liquidate these deposits.
For every withdrawal made from SVB, they sold their long-term bonds, which caused panic among the customers, and the bank collapsed 48 hours after revealing the sale of assets.
Traditional Bank Run
After announcing its $1.75 billion capital raise on March 6, concerns arose among people that SVB may not have enough funds to continue its operations. Panic ensued as news of the bank’s potential lack of funds spread quickly on social media platforms like Twitter and WhatsApp. This led to a surge of customers making cash withdrawals. The stock price of SVB plummeted by 60% on March 7 following the announcement of the capital raise.
On March 8, Californian officials closed the bank and placed SVB under FDIC. In contrast to personal banking, SVB’s clients had significantly larger accounts. The bank run caused the money to deplete rapidly, and the pace of withdrawals escalated, leading to a snowball effect. Since most customers had deposits exceeding the FDIC limit of $250,000, they could not recover their entire deposits.
Many startups chose to keep their money in their primary SVB account instead of utilizing other accounts, such as a money market account, to pay for their expenses. This meant that most of their working capital was held in their SVB account, and they required access to these deposits to manage their payroll and pay their bills.
They couldn’t run their day-to-day operations without access to their deposit and were left stranded. This SVB collapse can be equated to an extinction-level event for startups.
Final Thoughts
The collapse of Silicon Valley Bank (SVB) was a significant event that surprised many, given the bank’s reputation and assets. As a bank that catered to the tech sector, SVB played a vital role in funding startups that other banks deemed too risky. SVB’s downfall was due to a combination of factors, including a lack of portfolio diversification and a traditional bank run, and mismanagement from the management.
The collapse of SVB has devastated the tech sector, as many startups were left stranded without access to their working capital. The lesson learned from this is that banks must prioritize risk management, portfolio diversification, and effective communication strategies to maintain their credibility and reputation in the market. While the SVB collapse may be seen as an extinction-level event for startups, it is a cautionary tale for all banks to learn from and improve their risk management practices.
Related article: Silicon Valley Bank Downfall: Moving on from America’s 2nd Largest Bank Collapse
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