The Collapse of the American-Silicon Valley Bank!

A run on a bank is when a large number of depositors start withdrawing their funds, demanding their money back.

The fact is that any bank, howsoever strong cannot survive a huge run. It will fail. Even if it is healthy, the bank will need time and support to stay afloat. That is a fact of that business. Bankers dread nothing more than a run on a bank and will do anything to avert it.

Silicon Valley Bank was the 16^th largest bank in the US which failed on the 11^th of March 2023. A lot of depositors asked for their money back and the bank did not have the ready cash to pay them. That is a failure and it had to down its shutters as ordered by its banking regulator.

The Bank was a listed entity and its stockholders will face a total loss.

Silicon Valley Bank based in California was set up in 1993 to serve the growing tech ecosystem in the Valley. SVB would open an account for startups when no other bank would. Silicon Valley Bank offered tech companies a range of products: deposit services, loans, investment products, cash management, commercial finance, and more.

SVB  had a relationship with more than 50% of all venture-backed companies in the US., as per a report of Fortune.com. Venture or private equity funds make up approximately 56% of the bank’s global banking portfolio in 2022.

Let’s go back a bit into the basics of banking. A bank’s business is to take deposits from customers and extends loans to individuals or entities. The difference in what it charges its borrowers and pays its depositors is the spread or the profit it makes after deducting expenses.

From the deposits, the banks are required to keep aside a portion to meet withdrawals which are invested in safe very short-maturity government bonds. A portion may also be invested in other financial instruments which are designed by their investment committee. There are broad rules on every aspect of their business devised by the Central Bank, which they have to follow.

This is a very simplistic explanation, banks sometimes do a lot of financial juggleries which is their job. They assume risks to generate a return and are “supposedly experts and follow a rule-based system”.

Clearly, Silicon Valley Bank was a champion of the innovation ecosystem and walked the talk in supporting them. The Bank saw rapid growth during the boom period from 2019 to 2022, got an influx of deposits. The customers got funding from the venture capitalists and in turn, they placed deposits in SVB. Its deposit base tripled in 2019- 2022 to $198 billion dollars as its customers were well funded. The credit growth in the system did not match the deposit growth, so they invested a large portion – $80 billion dollars in US treasury and mortgage-backed securities which are considered safe bonds at a yield of 1.65-1.75%, which would mature in about 10 years.

The way the bond market works is that if interest rates rise in the system the price of the bond falls. Normally interest rates fall or rise gradually, therefore the movement in the value of bond portfolios is not very violent.In 2022 though fed increased rates from 0 to 5%. In bond markets this li like faster than lightning. The reasons for the fed to do so is sound, to control inflation but nonetheless, it’s a jaw-dropping rise.

It is a given. Most Banks all over the world will be holding bonds and in a rising rate environment, the portfolio will be in the red. The longer the maturity of the bonds in the portfolio bigger the potential loss if they are sold. But if the bank holds it till the bond matures, it will get back the money and the interest that is contracted will be paid.

If interest rates rise and there is a need to sell those bonds, they will have to be sold at a loss. If rates have risen rapidly, the losses would be unpalatable. The job of the management is to contain and manage the interest rate risk and keep enough liquidity. In the case of SVB, the risk was not managed well.

The customers were startups that saw lower funding from VCs in 2022, their businesses were burning cash faster and they needed money, Or, they thought they could earn a higher return elsewhere so they started withdrawing deposits.

Typically, banks have a mix of customers, small retail deposits, and customers from different industries who don’t act in a similar fashion as their needs will vary. Retailers with small deposits will not change banks for the sake of earning a slightly higher return. It’s too painful. But corporates will do so as every basis point increase in return for a CFO will make a difference to the bottom line.

SVB ran a concentrated Tech industry corporate deposit base. It worked well for them when the inflow was coming in. But when the exit started happening it became hard to manage and they took their time to book losses in their bond portfolios.

There are some technicalities there regarding the AFS portfolio (Available for sale portfolio) to HTM (Hold to Maturity portfolio), which is explained well here.

To meet withdrawals they sold bonds worth 21bn and incurred a loss of 1.8bn. They announced the loss at an inopportune time and also announced that they needed to raise capital.

A bank has to be very careful in announcing that it is stressed howsoever justified. It cannot use a startup language where making losses is worn like a proud medal. A whiff of trouble and customers will make a beeline to escape from the sinking ship. If the news spreads, a small hole is enough to decimate a bank.

The concentrated customer base talking to each other tweeting away, VCs instructing their companies to redeem their deposits brought SVB down in a matter of a couple of days.SVB must have tried its best to raise capital, or avail a line of funding but could not manage to do so. In the coming days, all the whys and the what’s and could have been for the bank will tumble out. Though, it is horrifying to know that the bank did not have a chief risk officer for the whole of 2022. There were analysts predicting the insolvency of the bank in Jan 2022, you can read about it here.

https://twitter.com/RagingVentures/status/1615826094271217664?t=iqiEjzbo4elVD2a7OxMIcw&s=19

Interest rates rise and fall. It is banking 101. Unfortunately, sometimes basic tenets of prudency like stop-loss, liquidity management, and supervisory oversight are ignored and the result is a disaster.

In the US, the Federal Deposit and Insurance Corporation insures deposits up to $250,000 dollars. They have been guaranteed. 93% of the SVB deposit base was not guaranteed. In the coming days, FDIC will sell the assets of the bank or sell them and pay back the other depositors.

How much will they get back depends on what value the liquidators can sell them. Typically, the regulators are very efficient and sensitive and carry this out as soon as they can. They do not want panic and the word is contagion to spread to other banks. For the SVB shareholders, it is a horrific ordeal. Especially for employees who have huge stock options. They lose jobs, and their wealth all at once.

In India, other than cooperative or regional banks, large banks are not allowed to fail by the regulator. A failing bank is merged with a stronger bank to protect the interest of depositors, eg: Yes Bank was merged with State Bank of India, Oriental Bank of Commerce (OBC), and United Bank of India into Punjab National Bank, Syndicate Bank into Canara Bank, Andhra Bank, and Corporation Bank into Union Bank of India, and Allahabad Bank into Indian Bank, Laxmi Vilas Bank with DBS.

The shareholders of the weak bank also recoup some losses.

Overall in my opinion this is not ideal but a preferable outcome.