Why SVB failed: the bank ignored one of the fundamentals of finance (2023)

If you're looking for reasons whyThe Bank of Silicon Valley went bankrupt, what wastaken over by the FDIC last FridayAfter one of the biggest bank runs in US history, an obvious culprit is that the bank broke one of the basic rules of finance: always diversify. SVB became the nation's 16th largest bank by becoming the financial institution of choice for Silicon Valley venture capitalists and the companies they founded. In doing so, however, it has also become particularly dependent on the health of the tech industry and the decisions of a relatively small number of VCs and company founders. This dependency has made the bank so successful. It also helped to destroy it.

It's hard to overstate what an unusual SVB bank was. At its peak, it had more than $200 billion in assets, but it had few retail customers and fewer than 38,000 corporate accounts. And its customer base was largely undiversified: most of its deposits came from venture capital funds and technology and life science companies, and most of its loans went to these companies as well. This was a conscious decision by the SVB: many times, in fact,necessary companiesto the bank exclusively as a condition for the financing.

That was great for SVB in the boom years of 2020 and 2021: its total deposits more than tripled in two years. But when the tech boom hit in late 2022, SVB's customers — many of whom were startups that didn't make money but spent it — began withdrawing instead of depositing, burning through cash to stay afloat.

That wouldn't have been a problem except for one thing: the SVB had taken a lot of those deposits in 2020 and 2021 and bought long-term government bonds and mortgage-backed securities, which had very low interest rates. This was not a totally reckless decision: none of the acquired assets defaulted. But it exposed the SVB to high risk when interest rates rose, because when interest rates rise, bond prices fall.

And of course that's exactly what happened in 2022. The result was that, at the end of 2022, SVB had unrealized losses on its investment portfolio, that is, based on the mark-to-market of its assets, with its liabilities barely covering their liabilities. (Had SVB been a larger bank, it would have been subject to stricter regulations and stress tests that likely would have kept it from falling into such a big hole. But the bank wassuccessful lobby, in 2018, for reversing those rules when it came to banks of this size.)

Despite this, SVB had more than enough liquidity to cover a normal withdrawal fee and last week it announced a plan to strengthen its cash position by selling part of its bond portfolio and raising capital by selling shares. This caused investors to panic (when a bank says not to worry, you wonder what to worry about). But if SVB had had a more traditional and diverse customer base, it might have weathered the storm well. Instead, it was plagued by its reliance on Silicon Valley and the VC community in particular.

Unlike typical bank customers, most SVB customers come from a relatively close-knit community. They are obsessive social media users. They talk to each other both online and in the real world. They tweet and retweet each other. In the case of VCs, there aren't many of them, and they wield outsized influence over the companies they fund. And, as we know from the long history of boom and bust cycles in technology, they aretends to keep– rush into similar investments at the same time and then run away from them when sentiment changes. When they began to worry about the financial health of SVB, the situation was almost perfect for a run on the banks.

SVB executives seem naively to hope that the relationships the bank has built with VC and the startup community over the years will help them get through this difficult period. On thursday,accordinglymold information, The bank's CEO, Greg Becker, told a group of top VCs that the bank would be fine if everyone didn't panic, saying, "I urge everyone to support us as we support you."

But it was a vain request. (They are called darecapitalistsfor a reason.) On the same day, Peter Thiel's Gründerfonds advised companies in its portfolio to withdraw money from the bank, and a number of other venture funds followed suit. And it wasn't just VCs. Accordinglyein Twitter-ThreadPer Alexander Torrenegra, CEO of Torre, an online job board, more than 200 tech founders discussed SVB's problems in a group chat Thursday morning, with people saying there are "only perks, no downsides" to spending your deducted money. (The downside, of course, was that the bank was going to fail, but for obvious reasons nobody cared.) Once a few companies started rushing for the door, it was almost inevitable that everyone would try to flee. And when it did, the SVB was toast.

In that regard, SVB fell victim to a rapid bank run of the social media age — a bitterly ironic fate for a bank that had funded so many tech companies. And its decline has been accelerated by another digital innovation: online banking. It used to be time-consuming to get your money out of the bank and transfer it to another bank, which meant banks had more time to avert disaster. Today you can do all this with a few clicks on your phone. Depositors and investors tried to withdraw $42 billion - nearly a quarter of the bank's total deposits - on Thursday. The next day, regulators shut it down.

SVB's collapse may not have had a real impact on other banks given their problems - an undiversified customer base, a large percentage of their deposits uninsured and a heavy reliance on corporate/VC customers (who are more likely to switch bank) - were mostly idiosyncratic. But the fear is illogical, and while SVB's demise appears to be largely the result of its own poor decisions and the rapid departure of its clients, federal regulators this weekend unveiled a plan to avert similar crises at other regional banks. . All SVB depositors are being restored, and the Fed has created a lending facility that allows banks that are at unrealized losses to borrow money to cover withdrawals.

This may be enough to quell the panic (although aBig sell-off on regional bank stocksMonday morning means it's not over yet.) But if there is a lesson to be learned from the end of the SVB, it is that medium-sized banks should be subject to the same capital rules as the big ones, and that banking regulators should be attentive to the degree of exposure of banks to a single sector. Eventually, SVB was ruined by the very industry that made it rich, along with a foolish investment strategy. And the same is true, to a lesser extent, for the other two bank failures we saw last week: Silvergate and Signature Bank of New York, both heavily dependent on the crypto industry and crypto-struggling companies moved after that FTX crashed. billions in cash. Turns out putting all your eggs in one basket works great - until the bottom falls out.