The failure of Silicon Valley Bank (SVB) has sent shockwaves through the financial and technology communities. The assets of the Santa Clara, California-based bank were seized by US regulators on Friday after depositors began withdrawing dollars in droves amid concerns about the lender’s financial health.
Since then, banking regulators around the world have worked feverishly to mitigate the damage from SVB’s failure, the largest bank failure in the United States since 2008, and restore trust in the global financial system.
As the name suggests, SVB’s business was largely focused on technology firms. During the COVID-19 epidemic, the banks saw an increase in deposits as tech firms benefited from offering entertainment and delivery services to those who were confined to their homes. SVB put a large portion of this money into US government bonds, which are traditionally one of the safest sorts of investments.
SVB’s problems began last year, when the US Federal Reserve began hiking interest rates in response to rising inflation, leading the value of those bonds to decline. “Rising interest rates in the US and a slowdown in startup funding in 2023 created a liquidity crunch for SVB much before the large-scale bank withdrawals happened. SVB invested in long-term, low-interest-bearing bonds in an almost zero-interest-rate market. However, as interest rates started increasing, their value started falling. These bonds are held-to-maturity instruments and unlike other instruments, aren’t marked to market, which means SVB could have possibly held them on their balance sheet without the need to reprice them and remained solvent,” said, Ashish Fafadia, Partner at Blume Ventures.
As the tech sector’s economic prospects deteriorated following the epidemic boom, many of SVB’s customers began to tap on their cash to stay afloat. SVB was obliged to sell its bonds at a large loss due to a lack of cash, raising concerns about its financial health.
Several depositors, concerned about the safety of their deposits as a result of social media information, made massive withdrawals within 24 to 36 hours. This exacerbated SVB’s cash problems and caused insolvency.
Elaborating on the macroeconomic factors that led to the collapse, Oliver Heinrich, Partner at Picus Capital, told BW Businessworld, “When it became public that SVB needed an equity infusion to cover holes in its balance sheet that arose from selling bonds below their face value, the stability of the bank was questioned, in turn leading to a bank run as depositors did not want to see their balances lost.”
Bank transfers used to take 2 to 3 days and required a trip to a bank branch. As a result, even if a significant number of depositors wished to withdraw money at the same time, banks had a channel of communication with them, such as sending out statements through the media to reassure them that their money was safe. In this case, however, SVB was unable to keep up with the quick flow of information via social media and had little time to engage with its depositors before to its eventual collapse.
There have been speculations about more banks facing struggles in the near future. Therefore, startups should be ready for the worst of the situation and ensure that they invest their money in more reliable alternatives.
“Companies should diversify their exposure by having accounts with different banks since the banking system does allow for bank failures and deposits are only insured up to a certain amount. In addition, there are low risk instruments in the money market that will ensure that start-up funds are not part of the bank’s balance sheet and would not have been affected by a bank run. This is particularly important for companies with large funding rounds, as simply diversifying will not be feasible to ensure themselves sufficiently, since the deposit insurance typically ranges between USD100,000 to USD250,000,” Heinrich explained.
Experts have been speculating that, since last year, the loss of valuation of tech companies, the large-scale layoffs in the tech and startup sectors, and the shuttering of Silicon Valley Bank and Signature Bank in the US are interrelated. “ Founders should be careful if their business model is over-indexed on a single point of failure. In this instance, it was having just one bank account with SVB. However, there could be other risks like having their business models aligned with a Government policy or on the increase in prices of certain goods. This makes them vulnerable to a future black swan event if there are any changes in the macro environment that are difficult to predict. The collapse of SVB and associated hardships should be the trigger to deeply rethink de-risking business models and not just diversifying bank accounts,” Fafadia added.