What Led to the Shutdown of Silicon Valley Bank and What to Expect Next?

Authorities have taken control of the assets of a prominent Silicon Valley bank, signifying the most substantial collapse of a financial institution in the United States since the peak of the financial crisis almost 15 years ago.

On Friday, regulatory authorities shut down Silicon Valley Bank, a major tech-sector lender, due to concerns about its financial stability. This triggered a broader stock market decline and raised apprehensions about the possibility of other banks facing similar risks.

This article outlines the events that led to the crisis and examines its potential implications for the tech and financial industries.

An Overview of Silicon Valley Bank

Established in 1983, Silicon Valley Bank grew to become the 16th largest bank in the U.S. with assets worth $210 billion. Over time, the bank’s client list reportedly included major names in the consumer tech industry such as Airbnb, Cisco, Fitbit, Pinterest, and Square.

Silicon Valley Bank was not a typical bank – it had become the favored choice for Venture Capital and technology sectors, earning the nickname of the “Startups bank.”

From its inception, SVB had taken deliberate risks, making focused investments. This strategy had proven highly successful for SVB in the past decade, particularly in 2020 when economic stimulus measures and interest rate reductions injected significant liquidity into the banking industry.

Reasons for its Closure.

SVB’s success as a go-to bank for the Venture Capital and technology sectors was undeniable in the past decade, particularly in 2020. However, the bank’s concentration of investments proved to be a double-edged sword. As with most banks, SVB operated on a fractional reserve system, where a portion of deposits is retained for withdrawals, and the rest is invested. While SVB made calculated risks and invested heavily in safe assets like US Treasuries, this approach still carried some risk.

The bank made a significant gamble when the Federal Reserve began raising interest rates in 2020, betting that the rate hikes would occur at a slower pace. Unfortunately, SVB’s investments in government-backed bonds worth $100 billion locked away for 3-4 years at a 1.79% interest rate became a liability when interest rates accelerated faster than expected. If SVB sold these bonds to maintain its liquidity, it would have to do so at a loss.

SVB might have been able to manage the financial loss if they had a more diversified portfolio. However, the bank’s client base was primarily made up of startups, which were receiving less funding and withdrawing more money to cover expenses. This placed a significant strain on SVB’s liquidity, as the bank needed additional funds to facilitate these withdrawals. Unfortunately, the only option available to SVB was to sell its bond positions at a loss to raise cash.

In an attempt to address the situation, on March 8, 2023, SVB announced plans to sell a third of its ownership in order to raise $2.25 billion. This was a difficult decision for the bank, as it had to accept a loss of $1.5 billion on its bond holdings. However, the funds were necessary to support the bank’s liquidity and enable it to process client withdrawals.

On Wednesday evening, Silicon Valley Bank announced its intention to raise $2 billion to bolster its financial position after suffering losses due to a slowdown in the tech sector. The bank also reported an increase in withdrawals by startup clients. Furthermore, it revealed that higher interest rates had caused a decline in the value of its securities.

As a result, massive sell-offs of SVB shares began by Thursday morning.

On the same day, CEO Gary Becker urged tech investors to remain composed, stating that the only potential risk to SVB would arise if rumors of its difficulties spread.

However, reports suggest that influential figures in the tech world, such as Peter Thiel, advised startup founders to reduce their exposure to SVB, which may have ultimately contributed to its downfall.

The situation took a dramatic turn the following day when the bank’s stock plummeted by 60% following rumors of SVB’s insolvency issues. In an attempt to reassure clients, the CEO made calls emphasizing the safety of their deposits. Nevertheless, on March 10, 2023, SVB announced that it had been unsuccessful in raising the necessary capital.

The bank began looking for potential buyers to take over the institution, but it was too late. The federal government intervened, and the FDIC seized control of the bank. The FDIC confirmed that all accounts were insured, and depositors would have access to their funds by Monday morning.

However, a significant issue arose, as FDIC insurance only covers deposits up to $250,000. Since the majority of SVB’s accounts are business accounts, 97.3% of these accounts are larger than the insured amount. While these companies may recover some of their funds when the bank’s assets are sold, it could take several years to do so

Garry Tan, CEO of Y Combinator, a startup incubator that has helped launch companies such as Airbnb, DoorDash, and Dropbox, described the situation as “an extinction-level event for startups.” He also mentioned that the incubator has referred hundreds of entrepreneurs to Silicon Valley Bank.

The White House confirmed that Treasury Secretary Janet Yellen was closely monitoring the situation. The administration aimed to reassure the public that the banking system was much healthier than during the Great Recession.

According to Cecilia Rouse, chair of the White House Council of Economic Advisers, “Our banking system is in a fundamentally different place than it was a decade ago. The reforms implemented during that time provide a level of resilience that we desire.”

In 2007, the global financial crisis was triggered when mortgage-backed securities linked to ill-advised housing loans declined in value. The crisis caused widespread panic on Wall Street and led to the collapse of Lehman Brothers, a company founded in 1847. As major banks had extensive exposure to one another, the crisis resulted in a cascading breakdown in the global financial system, resulting in millions losing their jobs.

At the time of its collapse, Silicon Valley Bank had $209 billion in total assets, according to the FDIC. The number of deposits exceeding the $250,000 insurance limit was unclear, although previous regulatory reports indicated that many accounts had surpassed the threshold.

What is Next?

The probability of the turmoil spreading to the wider banking sector seemed low, unlike the months preceding the Great Recession. The most significant banks, which have the potential to cause a financial crisis, have sufficient capital and healthy balance sheets.

According to Silicon Valley Bank’s website, nearly half of the technology and healthcare firms that went public last year after receiving early funding from venture capital firms were clients of the bank. SVB also highlighted its connections to prominent tech firms like Shopify, ZipRecruiter, and the top venture capital company Andreessen Horowitz.

Garry Tan estimated that approximately one-third of the startups associated with Y Combinator would be unable to meet payroll obligations within a month if they couldn’t access their funds.

The effects of the bank’s collapse are widespread, with internet TV provider Roku reporting that it had $487 million, or roughly 26% of its cash, deposited at Silicon Valley Bank in a regulatory filing on Friday.

Roku stated that its deposits with SVB were largely uninsured, and it was unclear to what extent they could be recovered. As a result of the bank’s seizure, the California bank regulators and FDIC transferred its assets to a newly established institution, the Deposit Insurance Bank of Santa Clara. This new entity will commence payments for insured deposits from Monday. Subsequently, the FDIC and California regulators intend to sell the remaining assets to reimburse other depositors.

Throughout the week, there was growing unease in the banking sector, with share prices plummeting by double digits. The news of Silicon Valley Bank’s financial woes further worsened the situation, pushing the share prices of nearly all financial institutions even lower on Friday.

In conclusion, the collapse of Silicon Valley Bank has sent shockwaves through the banking industry, raising concerns about the resilience of the financial system. The bank’s concentration of investments in government-backed bonds proved to be a risky bet when the Federal Reserve increased interest rates at a faster pace than anticipated. The resulting liquidity crisis put immense strain on the bank, leading to its eventual seizure by the FDIC.

While the situation is concerning, experts suggest that the reforms implemented since the Great Recession provide a level of resilience that should prevent the crisis from spreading to other institutions. However, the fallout from SVB’s collapse will be significant, with startups and other businesses who had accounts exceeding the insured limit facing an uncertain future. Ultimately, the situation serves as a reminder of the importance of diversification and risk management in banking and investing.

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