What the Silicon Valley Bank Collapse Means for American Consumers

Mar 15, 2023

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min read

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n March 10th, 2023, one of the largest banks, Silicon Valley Bank (SVB), collapsed. In just 48 hours, SVB became the largest bank to fail since the 2008 financial crisis and the second largest in US history. The collapse has sent shockwaves throughout the economy, creating chaos in the financial world and sparking fears of a looming crisis.

But how did SVB collapse, and what does it mean for American consumers? This article will dive into the factors that led to the bank's collapse, the consequences for customers and investors, and the potential implications for American consumers. Let's dig in!

What Is Silicon Valley Bank?

Silicon Valley Bank was established in 1983 to focus on the needs of startup companies. It quickly became the go-to institution for venture capital and tech startups, earning the nickname' Startups bank.' In fact, it was the banking service provider for almost half of all tech companies in Silicon Valley.

Even during the pandemic-ridden year of 2020, Silicon Valley Bank managed to flourish thanks to low-interest rates and the booming IT sector. It grew so much that it became the 16th largest commercial bank in the USA.

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Silicon Valley Bank's success was recognized by Forbes in February 2023 when it was ranked #20 in "America's Best Banks," with an impressive 13.8% return on equity. Moody's Investors Service also rated the bank's loan portfolio as conservative and high-performing.

However, just a few months after enjoying great success, the bank's abrupt collapse stunned the entire banking industry.

Why Did Silicon Valley Bank Collapse?

Silicon Valley Bank's collapse was caused by several factors, including poor management decisions, undiversified investments, and heavy exposure to the technology sector. These factors combined created a slow decline that ultimately led to the bank's collapse. Let's dive deeper into the causes.

Single Focus on Startups and Venture Capital

SVB was merely focused on tech startups and venture capital. This singular focus paid off handsomely during the pandemic, as the tech industry boomed and investors were eager to pour money into startups. Thanks to cheap credit, money was plentiful, and many startups had ample cash to store in banks. This resulted in a massive influx of deposits to SVB, which saw its deposit surge from $62 billion to $189 billion in 2021.

However, as the tech sector began to cool off, so did the cash inflows of these companies. Without new funding, many tech startups must rely on the money stored in banks to finance their day-to-day operations. This meant that SVB's main source of cash flow from these tech companies was drying up, and they had less cash inflow than outflow.

Unexpected Fed Interest Hike

With a massive influx of deposits, SVB was eager to find ways to make a profit. They invested $80 billion in long-term bonds and other securities, hoping to generate a decent return. But things didn't go as planned. At the time, interest rates were hovering around 1%, and SVB didn't anticipate the Federal Reserve's sudden hike. The rates of the bond reached 4%. This meant that the value of the bonds decreased significantly, resulting in massive losses for the bank.

Unfortunately, SVB had misjudged the situation, assuming that the venture capital market and rates would remain stable. The sudden interest rate hike caught them off guard as they had locked too much money in a single asset that yielded low returns.

Lack of Diversification

SVB's lack of diversification in its investment portfolio had dire consequences. The bank had invested heavily in long-term bonds without anticipating the sudden hike in interest rates. As a result, the demand and the value of bonds plummeted.

While it is not a realized loss if the bonds are held until maturity, SVB was unable to do so and was forced to sell the bonds at a loss of $1.8 billion. This was because their customers were mainly tech startups who needed to withdraw their deposits to fund their daily operations in a high-interest-rate environment where financing became increasingly challenging to secure.

The bank's decision to invest short-term deposits into long-term, fixed-rate assets was risky and backfired. It's important to note that banks typically have capital from multiple sources to cover customer withdrawals, but SVB's niche market made it difficult to do so in this case. This meant that the bank had put all its eggs in one basket, making its investment portfolio risky and vulnerable to market fluctuations.

Incompetent Management

Clearly, the Federal Reserve's interest rate hike played a role in SVB's loss, but it's not the only factor at play. The bank had plenty of time to prepare for rising interest rates, yet they failed to do so. The incompetence of the management team is a significant contributor to the bank's collapse.

One glaring example of this was the lack of a chief risk officer for eight months, precisely when the bank's portfolios needed to be rebalanced to account for the higher interest rates. This lack of leadership was akin to a plane flying without a pilot in the middle of a storm, and it was only a matter of time before the bank crashed.

If the management team had proactively prepared for potential risks and sold the long-term bonds before their value dropped significantly, it could have saved from the collapse.

Political Lobbying

After the 2008 financial crisis, Dodd-Frank Act was enacted, making banks face stricter regulation to avoid a similar crisis. But, in 2015, SVB CEO lobbied lawmakers to exempt banks with less than 250 billion from the act. In 2018, a bill was passed, weakening this act.

This political lobbying proved to be a costly mistake for SVB. By pushing for exemptions from Dodd-Frank regulations, SVB left itself vulnerable to the consequences of its actions. Without adequate oversight and regulation, this may have encouraged the management team to take on too much risk without considering the potential effects.

Furthermore, the fact that the CEO of the bank was on the board overseeing its own supervision is an apparent conflict of interest. This lack of oversight and accountability may have contributed to the poor decision-making that led to SVB's losses. In short, the bank's short-sighted lobbying efforts proved to be its own downfall.

The Last Resort Failed Terribly

SVB knew the ship was sinking and decided to raise the capital to save it. Although this seemed like a reasonable decision, the timing was unfortunate, and it proved to be a grave error and turned out to be the final strike for its collapse.

A few days prior, Silvergate, a small crypto-focused bank, failed for similar reasons. The bank had lost significant assets due to the rising interest rates. This caused many to believe that SVB was headed toward a similar fate. Consequently, the bank's reputation and share prices took a significant hit, plummeting by 60% in a single day.

As a result, many customers withdrew their funds, leaving the bank with no cash reserve. The bank attempted to find a company to provide a bailout, but no one was willing to get involved. Thus, the bank was forced to close down.

Deadly Bank Run

The SVB relied on a fractional reserve banking model, in which it only needed to keep 10% of deposited funds available and could use the remaining 90% for investments. However, this system can become problematic during a bank run when many customers simultaneously withdraw their money.

When rumors began to circulate about the potential collapse of SVB, many depositors became fearful and rushed to withdraw their funds. This reaction was understandable since the FDIC only insures up to $250,000 in refunds, and 97% of SVB's deposits exceeded this limit due to its focus on technology companies.

With many depositors attempting to withdraw their funds simultaneously, SVB had no cash reserves to meet their demands. Furthermore, the bank's investments were also incurring losses, leading to its eventual collapse.

Potential Fraud

There are allegations among investors that the collapse of SVB may have been pre-planned. Shareholders have filed a lawsuit against the bank's parent company, CEO, and CFO, claiming fraud. The basis of the lawsuit is that top officials of the bank sold their shares just one week before the bank's collapse, and these shares were traded automatically.

Additionally, employees received annual bonuses only an hour before the bank crashed. These events have led to the belief that the bank's top officials were aware of what was happening and acted in their own self-interest.

It is worth noting that the Chief Accounting Officer of SVB was previously the CFO of Lehman Brothers, which triggered the 2008 financial crisis. This fact may raise further questions about the bank's management and practices. As the lawsuit moves forward, more details may emerge about whether or not fraud was indeed committed by SVB's top officials.

What About Depositors and Investors?

US regulators have assured SVB's customers that all their deposits will be guaranteed. This step aims to prevent any further bank runs and maintain stability in the tech industry associated with the bank.

However, this guarantee does not extend to the investors who have invested in the bank. This unfortunate situation means that the investors may be unable to recover their invested capital and any anticipated returns.

Is This Another 2008 Financial Crisis?

Many are drawing parallels between the current situation and the 2008 financial crisis. However, it's important to note that this crash has a different root cause: the inability of banks to adapt to changing interest rates. This has highlighted small and midsize banks' challenges that focus on niche businesses and may be more vulnerable to bank runs.

One crucial distinction from the 2008 crisis is that, back then, taxpayers shouldered much of the burden of rescuing the banking industry with hundreds of billions of dollars. In the case of Silicon Valley Bank, the costs of rescuing depositors will be financed by fees paid by other banks into the FDIC.

However, the crash of SVB could set off a chain reaction that could have consequences for startups and the entire financial system. The effects of the SVB's crash have already been felt as banks such as First Republic Bank and Pacwest Bancorp have seen their shares plummet by 65% and 52%, respectively.

Additionally, it's not just SVB that's been affected either. Many financial institutions have seen their investments in government bonds and other assets fall dramatically. Fortunately, the government has been proactive in response. Recognizing the potential for more bank failures on the horizon, the Fed announced a funding program to help other at-risk banks.

In an unprecedented move, the Fed is allowing banks to sell their long-term bonds and securities to the Fed without suffering losses. The Treasury and FDIC have also stated that all depositors, even those uninsured, will be made whole without any expenditure of taxpayer money.

While the crash of a bank can often cause people to panic and withdraw their money, leading to bank runs and further complicating the issue. So, if the Fed's actions can break the chain of events, the possibility of having a financial crisis can be saved.

Is Money Safe in the Bank?

Character Questioning — Source : Freepik

The safety of your money in the bank depends on whether or not it is FDIC insured. Fortunately, if your money is FDIC insured, it is considered safe, even if the bank crashes. The FDIC insures your money up to a specific limit of $250,000 per depositor, per account type, at each insured bank.

So, as long as your money is FDIC insured and within limits, you can have peace of mind knowing that your money is safe in the bank.

Will Other Banks Fail as Well?

It's possible but unlikely as long as the bank is properly managed and adapts to changing circumstances. The issue with SVB was that it was focused on servicing niche markets such as startups, and its funding from venture capital was drying up. This led to more money flowing out than coming in, and the bank locked away too much cash in securities that were not yielding good returns.

What ultimately caused the downfall of SVB was a lack of effective management and an inability to adapt to the changing high-rate interest environment. This also highlighted the challenges for a bank of similar nature. However, the lessons learned from this experience can help other banks avoid similar future pitfalls.

Any Precautions to Protect Money?

No matter the situation, it's crucial to take necessary precautions just in case. Here are some steps to take to protect your money:

Make Sure Your Deposits Are FDIC Insured

The FDIC insures up to $250,000 per person, per bank, and per account type, so it's best not to put more money in the bank than this amount. If you exceed the amount, it's wise to spread money between accounts without exceeding the insured limit.

You can use FDIC's Electronic Deposit Insurance Estimator tool to know whether or not you're fully covered.

Diversify Your Portfolio

The collapse of SVB shows how an investment in one asset can suffer dramatic loss and drastically affect you. So, make sure your assets are diversified. Don't put all your money in the bank. Diversify it to stocks, fixed assets, and other investment vehicles.

Have Emergency Savings

Make sure to save up to three to six months' worth of living expenses in an easily accessible account, like a high-yield saving account, in cases of emergency. Having accessible savings in the case of a crisis can prevent you from being forced to sell your assets at a low price.

Review the Financial Plan

It is essential to periodically review your financial plan to ensure it is still relevant and effective in the current environment. By staying proactive and taking these precautions, you can help to protect their money and mitigate potential risks.

Stay Informed

Keep up with the latest news and market trends affecting your investments. It's wise to consider consulting with a financial advisor if you have questions or concerns.

Are Certain Banks Safer to Keep Money in Than Others?

In general, keeping money in a bank is a safe option, as the amount deposited is typically FDIC-insured. Bank failures are rare, and the FDIC ensures that your money is secured even if the bank fails.

However, there are alternative options to banks that may be considered safer for some people. One such option is credit unions. Credit unions are typically non-profit organizations, not driven by profit motives. This can make them a safer option for depositors, as they are not investing their money in various investments that could potentially lead to losses. Additionally, credit unions operate differently from banks. The depositors are members, which gives them the power of decision-making.

Therefore, while banks are generally considered a safe option for keeping money, credit unions can offer additional safety and security, especially for those prioritizing transparency, accountability, and community-driven financial services.

Conclusion

The collapse of Silicon Valley Bank serves as a reminder of how risky it is to put all the eggs in one basket and how it is essential to have a contingency plan in changing environment. The Silicon Valley Bank's collapse resulted from a failure to diversify assets, adapt to changing circumstances, poor management decisions, and a lack of a contingency plan for a crisis.

When one bank falls, it creates a ripple effect that can cause a financial crisis, inducing panic and uncertainty among the public. It's vital to break that chain of events. So, rather than panicking, taking precautionary measures to safeguard your hard-earned money is wise. Remember, in the ever-changing world of finance, one must always be prepared for the unexpected.