Silicon Valley Bank: How it Crashed and its Effects

• January 29, 2024

• Mustafa Eren

It is Friday, March 10, 2023, a bonus day for the eight thousand employees at Silicon Valley Bank (SVB). The employees receive their bonus, but a couple of hours later, SVB Collapses. The following Monday, a long line of customers can be seen lined up in front of the bank, quickly attempting to retrieve their funds. How did this collapse transpire? And how could we prevent a similar situation from occurring in the future? In order to better understand the bank's plummet, it is essential to explore SVB's background and its impact on the financial market before its downfall.

SVB was established in 1983 in Santa Barbara, California, with the aim of supporting entrepreneurship in the technology and life sciences sectors. It primarily specialized in venture banking for technology companies and is well renowned for supporting tech startups. The bank also incorporated M&A advisory services, funds management, investment banking, and other banking services in its latter stages (Vo, pg. 8). The bank has opened various branches in regions like Asia, Europe, and the U.S. (Vo, pg. 8). Over the past forty years, SVB has significantly expanded its growth and popularity, increasing its total assets from $956 million in 1992 to $70 billion in 2019. SVB’s success can be attributed to its strategy of targeting higher-risk clients, specifically tech startups, which were often declined by other banks with a lower risk appetite (Hetler). Amidst the pandemic, most technology enterprises experienced a substantial surge in monetary funds, which necessitated SVB's services to deposit their cash. The result was prosperous, and the future looked auspicious for SVB: Their total assets reached a peak in the first quarter of 2022 with a value of 218 billion dollars, placing them as the 16th largest bank in the U.S. (Vo).

So, what led a financial institution with such an esteemed reputation to stumble and hit rock bottom? To understand the collapse, we must look at how interest rates changed from the pandemic to today. During the pandemic, the Federal Reserve combatted the recession by lowering interest rates to nearly zero percent. This is because lower interest rates encourage more borrowing, which produces more money for the economy, stimulating more growth. SVB decided to make a profit by investing long-term by putting most of its assets into government bonds when the interest rates were nearly zero percent. The biggest issue was that they didn't invest in liquid assets in the short- term, which proved detrimental in their collapse. Then, at the start of March 2022, the Federal Reserve suddenly hiked up the interest rates to combat potential inflation. As a result, existing government bond prices started declining because new bonds were issued at a higher interest rate. Think of it like this: You go to a video game store and purchase Modern Warfare III. You can sell this game at a higher price than Modern Warfare II because it is the newest version. Similarly, if you have a bond that is issued at 2% and the interest rate increases to 3%, the bond issued with a 3% coupon rate would look much more attractive to investors. The only way for you to sell the bond is by discounting its price. So, when the Federal Reserve raised interest rates, SVB’s assets depreciated in value. Most of this money essentially belonged to tech companies and startups. To protect their investments, they pumped more money into the bank but had difficulty generating capital on their end, causing their stock prices to fall. This is one of the reasons there have been a lot of layoffs in tech companies since 2021.

On March 6, When the bank announced that it was going to raise its capital by $1.75 billion, customers became alarmed that the bank was out of money. The word spread rapidly via social media and personal contacts, prompting a mass withdrawal of funds. The next day, SVB's stock plunged by 60%, leaving California regulators to shut the bank down the subsequent day and subject it to the supervision of the FDIC (Federal Deposit Insurance Corporation). The people who were affected most by this collapse were stockholders and investors. This is because FDIC only compensates investors that have at most $250,000 in their accounts. In the case of SVB, 90% of its customers had more than this amount in their accounts.

So now that you understand how SVB collapsed, you might ask, "Why didn't the bank prevent all of this by paying all of its depositors at once?" Unfortunately, banks don't operate this way; if they did, there wouldn't be economic growth. The best way to explain this complex procedure is through a real-life situation. Imagine you, the reader, deposit $10,000 into my bank. Let's say the current reserve ratio is %10. This means I will only keep $1,000 in the vault as liquid cash and invest the remaining $9,000 into businesses and borrowers. Let's then say the money is loaned into a pet store business for their new grooming products. I give the pet store owner the $9,000 and charge interest on that loan while also giving you a small portion of the money I earned from the interest as a thank you. Then the pet store owner goes to the product seller and purchases the items. Then the product seller takes the $9,000 and stores it in their bank. Their bank will do the same as my bank did to you- they only have to keep $900 of the $9,000 in the bank and can lend the rest out ($8,100). And what do you know, a marine biologist needs a loan to purchase a microscope. Do you see the pattern? Your $10,000 repeatedly gets loaned out to multiple banks. This process is called the money multiplier effect, and its impacts depend on the reserve ratio. The lower the reserve ratio, the more money banks can loan out and generate more money in the economy.

While the money multiplier effect can contribute to economic growth, it can also make the banking system vulnerable to financial shocks. As we saw in the case of SVB, a sudden loss of confidence from depositors can have devastating consequences. During a period of financial uncertainty, depositors panicked and withdrew all the money they had deposited within SVB. This triggered a chain of events that ultimately led to the bank running out of cash and collapsing. SVB has taken some steps to remedy the damage on its front. They have hired William Kosturos, former reconstructing chief for Washington Mutual in the 2008 collapse, as their chief reconstructing officer. Additionally, the FDIC has transferred all of SVB's deposits to a newly created "bridge bank" so that depositors can have their money as soon as possible.