15 March 2023 The Collapse of Silicon Valley Bank

The Collapse of Silicon Valley Bank​

What do you need to know this week?

Seemingly overnight, Silicon Valley Bank (SVB) collapsed in what is the most significant banking failure since the 2008 failure of Washington Mutual. The Bank of England has placed SVB’s UK arm into resolution, which refers to a special insolvency procedure reserved for banks that are unable to meet customer deposit demands.

SVB UK caters to 3,500 business customers, the vast majority of which keep current accounts with SVB. While the Bank of England certifies all deposits up to £85,000 (or £170,000 for joint accounts), many businesses operate current accounts with balances that far exceed the maximum coverage.

Given SVB’s (prior) reputation as a premier commercial bank for venture capital-backed companies, UK startups operating in the life science and technology spaces are disproportionately exposed to SVB. On Monday morning, it emerged that HSBC would purchase the bank for £1 and presumably recapitalise it so depositors can access their cash.

Why is this important for your interviews?

SVB’s collapse typifies the boom-bust cycle that has characterised the frothy venture capital (VC) markets since 2020. Therefore, if you can articulate the reasons that led to SVB’s collapse, you will demonstrate to interviewers that you understand both the commercial drivers of banking as an industry, as well as the factors specific to the VC markets that led to SVB’s ruin.

Banks like SVB make their money by receiving customer deposits and reinvesting the money into assets with a higher rate of return than what they pay to their customers to bank with them. (The technical term for this net interest margin.) These assets typically include making loans to other businesses, as well as buying various government and corporate bonds.

The perineal risk for any bank like SVB is that it is unlikely to have enough cash on hand if every customer demands SVB return their cash to them at once, in what is called a bank run.

In practice, it is rare for factors to converge in such a way that leads to a sufficient number of customers demanding their deposits so as to constitute a bank run. However, that is precisely what happened in SVB’s case and can be explained by the fact that SVB’s customer base, being primarily VC-backed businesses, exists as a relatively small network of investors and senior managers. Like all small networks, people are always talking to one another. Fear spread quite quickly among customers last week that SVB had insufficient funds to meet customer deposit requests, which created a self-fulfilling run on the bank as customers moved to withdraw their funds before the rest.

As to what inspired the fear in the first place, the answer lies in the VC markets itself. From 2020 until the end of 2021, record low-interest rates encouraged investors of all stripes to pile their money into startup companies through various seed-stage equity fundraises because, as an asset class, startups offered some of the highest rates of return. As VC-backed companies banked the fundraiser proceeds with SVB, the value of SBV’s deposits nearly doubled.

SVB struggled to reinvest the deposits in yield-producing liquid assets like short-term government bonds because, in many cases, the rate of return was zero. As a result, its leadership made a grave miscalculation when, according to the FT, it purchased a $120bn portfolio of US government-backed debt in pursuit of a mere 1.64% of yield. The nature of this investment meant that SVB’s cash was now tied up for at least ten years. But as the FT exposé notes, the investment was undertaken on the false premise that interest rates would not increase in the future.

When inflation started to bite worldwide and central banks began hiking interest rates in December 2021, the bond portfolio’s value decreased by $15bn, which was an amount roughly equivalent to SVB’s capital. Effectively, this prevented SVB from trying to offload the portfolio because, by selling it, this would crystallise the loss on SVB’s books and wipe out the value of SVB’s ownership.

Nor could SVB hope to pad its position by receiving additional customer deposits because the interest rate hikes caused investors to pull out of venture capital into less-riskier assets. In the ensuing months, SVB tried to sell off various assets to improve its position and improve profitability, but by this point, SVB’s own shares had massively devalued. Despite various attempts by SVB to raise additional funding, by last Wednesday, 8 March, fear broke through and SVB’s customers began their run due to the perception that SVB had lost control of its business.