Silicon Valley Bank: How Does a Bank Collapse in 48 Hours?

Last Wednesday, Silicon Valley Bank (SVB) was a well-capitalized institution seeking to raise some funds. Within 48 hours, a panic induced by the very venture capital community that SVB had served and nurtured ended the bank’s 40-year run. SVB, facing a sudden bank run and capital crisis, collapsed Friday morning and was taken over by federal regulators. It is the biggest bank to collapse since Washington Mutual failed in 2008 during the financial crisis, and the second-biggest bank failure in US history.

Founded in 1983, SVB provided financing for almost half of US venture-backed technology and healthcare companies. While relatively unknown outside of Silicon Valley, SVB was among the top 20 American commercial banks, with US$209 billion in total assets at the end of last year, according to the Federal Deposit Insurance Corporation (FDIC).

Bank failures can come from various causes: fraud, bad lending or a mis-match of assets and liabilities. It appears that asset-liability mismatch was behind the bank’s problems. The demise of Silicon Valley Bank wasn’t driven by credit problems but by an old-fashioned mismatch of assets and liabilities that doomed many thrifts back in the 1970s.

Why did it fail?

SVB saw a huge influx of deposits from 2020 through early 2022. Deposits reached $198 billion on March 31, 2022, up from $74 billion in June 2020. Banks need to do something with customer deposits and SVB decided to put the bulk of the money into bonds, mostly federal agency mortgage-backed securities. These carry minimal credit risk but can have sizable interest-rate risk.

To combat rampant inflation, the Federal Reserve has been aggressively raising interest rates since 2022. It made borrowing for businesses and individuals more expensive to cool the economy down. When interest rates were near historical lows, the banks bought up on long-dated, seemingly low-risk Treasuries. But as rates rose, the value of those assets has fallen, leaving them sitting on unrealized losses.

SVB’s mistake was investing in longer-term mortgage securities with more than 10 years to maturity, rather than shorter-maturity Treasuries or mortgage issues maturing in less than five years. This led to an asset/liability mismatch. As interest rates rose sharply and the bond market cratered in 2022 (bond prices move inversely to yields), SVB’s bond portfolio took a huge hit. At the end of 2022, SVB held $117 billion of securities, which accounted for the bulk of its $211 billion in assets.

Higher interest rates also eroded the value of long-term bonds that SVB and other banks gobbled up during the era of ultra-low, near-zero interest rates. SVB’s US$21 billion bond portfolio was yielding an average of 1.79 percent — the current 10-year Treasury yield is about 3.9 percent.

One of the major problems is SVB’s massive exposure to rising interest rates. SVB used floating-rate deposits to buy fixed-rate bonds. They should have swapped the bonds to a floating rate — this is common practice in a well-managed bank.

High rates significantly constrained tech companies, which undercut the value of tech stocks and made it difficult to raise funds. Faced with higher interest rates, loss of IPOs, and a funding drought, SVB’s clients began pulling money out of the bank.

SVB compounded the problem by relying on institutional deposits, with the vast bulk of its deposit base consisting of accounts of more than $250,000. This made it more vulnerable to a run. SVB’s loan book looks in good shape, with losses of just 0.15% on a $74 billion portfolio in the fourth quarter. SVB was unusual because of the extent of its bond losses relative to its capital base compared with largest banks and regionals.

On Wednesday, the Bank announced a loss of approximately US$1.8 billion from a sale of investments (U.S. treasuries and mortgage-backed securities), and that it would also sell US$2.25 billion in new shares to shore up its balance sheet.

SVB CEO Greg Becker lobbied the government to relax some Dodd-Frank provisions on regional lenders in 2015. Trump did in 2018. Trump eased oversight of small and regional lenders when he signed a far-reaching measure designed to lower their costs of complying with regulations.

A measure in May 2018 lifted the threshold for being considered systemically important — a label imposing requirements including annual stress testing — to $250 billion in assets, up from $50 billion. SVB had just crested $50 billion at the time.

By early 2022, it swelled to $220 billion, ultimately ranking as the 16th-largest US bank. And the actions of SVB Financial Group CEO Greg Becker added fuel to the fire. He sold significant personal stock holdings (US$3.5 million) on February 27. Was it coincidental?

The sudden need for fresh capital, coming on the heels of the collapse of crypto-focused Silvergate bank, sparked another wave of deposit withdrawals on Thursday as VCs instructed their portfolio companies to move funds, according to people with knowledge of the matter.

The bank’s clients panicked at the news. By the end of Thursday, US$42 billion in deposits were withdrawn from Silicon Valley Bank. By the close of business that day, SVB had a negative cash balance of US$958 million, according to the regulatory filing, and failed to scrounge enough collateral from other sources, the regulator said.

By Friday morning, trading in SVB shares was halted and it had abandoned efforts to quickly raise capital or find a buyer. California regulators intervened, shutting the bank down and placing it in receivership under the FDIC. The FDIC will liquidate the bank’s assets to pay back its customers, including depositors and creditors.

Not later than Monday morning, all insured depositors will have full access to their insured deposits i.e. up to $250,000, according to the FDIC. But the vast majority of SVB’s customers were businesses that had more than that on deposit at the bank. As of December, more than 95% of the bank’s deposits were uninsured, according to regulatory filings.

Many of these depositors are startups, and many are concerned that they will not be able to make payroll this month, which in turn could spark a wide wave of failures and layoffs in the tech industry. The ramifications could be far-reaching, with concerns that startups may be unable to pay employees in the coming days, venture investors may struggle to raise funds, and an already-battered sector could face a deeper malaise.

Lenders somewhat similar to SVB are in an unfortunate situation. Voices from tech and finance are increasingly calling for the federal government to push another bank to take over the failed Silicon Valley Bank to protect uninsured deposits. Their main concern is that a failure to protect deposits over $250,000 could cause a loss of faith in other mid-sized banks. These banks are not deemed “too big to fail” and do not have to undergo regular stress tests or other safety valve measures passed in the wake of the 2008 financial crisis.

KPMG gave Silicon Valley Bank a clean audit report 14 days before it collapsed. It blessed Signature Bank’s books 11 days before. The auditors need to answer too.

The risks of broader contagion are thought to be limited for now. SVB’s collapse is unlikely to set off the kind of domino effect that gripped the banking industry during the financial crisis, but contagion effect cannot be ruled out.

The bank’s demise could prompt regulators to take a look at the accounting for bank bond portfolios that allow banks to effectively hide losses by classifying them as held to maturity. The other category for bondholding, available for sale, needs to be carried at market value.

10 thoughts on “Silicon Valley Bank: How Does a Bank Collapse in 48 Hours?

  1. Manojit Dasgupta

    Very well narrated. Fed Reserve’s aggressive plan to hike interest rates to combat inflation and too much investments in bonds by SVB is said to be the main reason for collapse. Lehman crisis was also due to much investments in housing sectors. That crisis had wider impact. But where has G20’s decade long much discussed financial stability risk gone? Can we really blame KPMG for not ringing the alarm bell when the bank was showing huge profit just last FY? SVB was also funding Flipkaet, Zomato and other budding startups in India. Hope the axe will not fall on the employees.

    Liked by 1 person

  2. Nilanjana Moitra

    Silicon Valley revolutionized the digital age and another namesake is now starting a sequence of bank collapse just after 12 years of the big financial crisis. Nice explanation of the reason for the downfall.

    Liked by 1 person

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