Why Did Silicon Valley Bank (SVB) Collapse?

n 2021, interest rates were rock bottom, and VCs (venture capitalists) were keen to lend money. Silicon Valley Bank (SVB) was the bank of choice for them and their clients to hold their deposits. As the name suggests they specialised in this niche for start-ups, and reportedly in 2015, 65% of all start-ups in the US used SVB. 

Probably expecting that rates would stay low, SVB took these deposits and invested them into long-dated treasuries, not necessarily something out of the ordinary for a bank to do. They’re relatively safe, highly liquid, can be sold if needed, and they pay some interest. 

Then 2022 happened. Inflation hit peaks not seen in decades, and the Fed raised rates at a pretty fast pace to combat it. When the Fed does this, or there’s an expectation they will, it can cause other rates in the economy to rise too. Such as those on the bonds SVB had been investing deposits into. 

If you’re not sure how bond prices work, they have an inverse correlation with the interest rate. If the interest rate goes up, the value of the bond goes down. And boy, did interest rates go up that year! That means the bond values were declining and heading into a loss. 

Now this doesn’t matter so much if SVB held those same bonds to maturity, as they would have been repaid the whole bond along with the interest anyway. So, those losses would never have been realised. But that’s not what happened.

High interest rate environments aren’t great for start-ups, and withdrawals started to hit SVB. This wouldn’t usually be an issue for traditional banks, since they have diversity among their clients meaning liquidity would be coming in as deposits are going out. But for SVB, with a heavy focus on start-ups, the withdrawals started outweighing deposits and they needed to sell some of their bonds at a loss to cover them.

The Dominoes Begin to Fall for SVB

They also still had massive holdings of low-interest bonds, with an unrealised loss of $15 billion. Which sounds like they failed pretty spectacularly against hedging interest rate risk.  

The holdings of low-interest bonds that SVB still held had an unrealised loss of $15 billion; meaning they hadn’t done a good job of hedging against interest rate risk. The credit rating -agency Moody’s noticed this and were preparing to downgrade their credit rating. As a result, SVB sold a bunch of bonds at a loss to improve their balance sheet. 

This caused some panic among VCs, as they feared the bank may run out of cash for withdrawals. So, they began to advise their clients to withdraw their money, and move deposits elsewhere. A run on the bank was imminent.

A bank run happens when a large number of people lose confidence in a bank and withdraw their money all at once. This can be sparked by rumors or news of financial trouble, which can cause a domino effect as more and more people try to withdraw their funds. The problem with a bank run is that banks typically don't keep all of their customers' money on hand, instead using it for investments and loans. If too many people try to withdraw their money at once, the bank can run out of cash and be forced to close its doors. This can have a devastating ripple effect on the economy, as people and businesses lose access to credit and the ability to conduct transactions, leading to a wider economic downturn. This was seen during the financial crisis, a few years later during the sovereign debt crisis in Europe, and in the Great Depression as shown in my mum’s favourite film It’s a Wonderful Life.

And this is what SVB were facing. To cover the withdrawals, they were having to sell even more bonds at a loss and by that afternoon their stock price was in freefall, bringing down other bank stocks with it as investors began to fear another 2008-like crisis was on the horizon. 

On Friday morning, trading in SVB stock was halted. Regulators came in and placed the bank under the control of the FDIC. 

Is SVB Going to Trigger a Financial Crisis?

It’s too early to know for sure how big the scale is of what’s being faced. Fortunately, early signs are not pointing to anything like the 2008-crisis. Big banks such as JPMorgan are usually more diversified, with troubled banks often being more specialised or regional, such as Silvergate, which focuses on crypto, although it’s not on the same scale as SVB. 

However, SVB is still a major bank, with many businesses choosing to deposit there. It’s the second biggest bank in US history to collapse. If those depositors find they can’t access deposits, that could result in massive layoffs, and a shock to economic growth. 

Governments, including central banks in major economies, were working over the weekend to find a solution. The UK arm of SVB has been purchased by HSBC, which means the government doesn’t have to step in to protect depositors. Sp crisis averted there it seems. 

However, no such deal has happened in the US yet, at least at the time of recording this - although things are moving quickly.

For now, regulators in the US have guaranteed that depositors will be able to access all their cash, even if it’s uninsured, as a big worry was that the FDIC only protects up to $250,000, but businesses generally had much more than that; well into the hundreds of millions in some cases.

Still, this has rippled through the markets, and current price moves suggest people may think the Federal Reserve may be about to stop hiking rates, and even begin cutting in May. However, the labour market is still strong, and inflation is persistent, so it’s possible the markets have overreacted. 

This is still a developing situation though, all eyes will be on governments and regulators to see if they can reassure depositors at other banks, and avoid more bank runs. Or perhaps, in a worst case scenario, this could just be the beginning, like a New Century moment from back in the financial crisis. Doubtful, but time will tell.