Collapse of Silicon Valley Bank
The collapse of Silicon Valley Bank (SVB) in March 2023 marked the second-largest bank failure in U.S. history, trailing only Washington Mutual's collapse in 2008. Rapidly transitioning from a robust institution to insolvency within just two days, SVB faced a bank run as depositors rushed to withdraw their funds amid rising inflation and deteriorating financial conditions in the tech sector, where many of its clients operated. SVB had heavily invested deposits into long-term treasury bonds, which lost value as the Federal Reserve raised interest rates. Consequently, the bank was unable to meet withdrawal demands, leading to significant losses when it had to sell these bonds at unfavorable prices.
Ultimately, federal regulators closed SVB, which had approximately $175 billion in customer deposits, and the Federal Deposit Insurance Corporation (FDIC) stepped in to manage the fallout. The bank's assets and deposits were later acquired by First Citizens Bank. The failure of SVB also triggered a crisis of confidence in the banking sector, contributing to the collapse of Signature Bank shortly thereafter. Analysts pointed to poor risk management practices by SVB’s leadership, lack of oversight, and the concentrated nature of its depositors as key factors in its rapid demise. The incident raised broader concerns about regulatory frameworks and the stability of banks heavily linked to volatile sectors.
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Collapse of Silicon Valley Bank
The March 2023 failure of Silicon Valley Bank (SVB) was the second largest such failure in US history, behind Washington Mutual’s in 2008. In two days, SVB went from functioning to insolvent when depositors rushed to SVB to withdraw their funds. The bank was ultimately closed by federal regulators in a matter of days. The reasons why the bank went insolvent could be traced to several factors. For one, it was a bank in the technology sector, and many of its companies were tech startups that concentrated money in just one sector. Also, experts say when inflation rates rose, many companies began to struggle to gain additional financing from venture capital, so they went to SVB to withdraw their funds, some even tried to withdraw all their money, resulting in a run on the bank. When this happened, SVB did not have all of that cash on hand because it invested the money from depositors in low-yield treasury bonds that would pay interest. They sold them quickly and at a loss. As a result, they had to try to raise more money by issuing their own bonds on the open market. All of that led to even more worry among their customers.
The collapse could not have come at a worse time, as many people in the United States were fearing a recession. Eventually, the Federal Deposit Insurance Corporation (FDIC) eventually took over the bank, which had $175 billion in customer deposits. Later, First Citizens Bank purchased SVB and assumed the majority of its deposits and loans. First Citizens Bank will purchase about $72 billion in assets at a discounted rate of $16.5 billion. FDIC will remain in control of $90 billion in assets and securities in its receivership. All seventeen of SVB’s branches will operate under Silicon Valley Bank, a division of First Citizens Bank.
Background
Based in Santa Clara, California, SVB was founded in 1983 with a specialty in financing and banking for venture capital start-up companies. The first branch was set up in San Jose, California, and it went public in 1988. It was the sixteenth-largest bank in the country. Its customers were technology startups, and it eventually became the largest bank by deposits in Silicon Valley. The bank had assets of about $209 billion in December 2022. SVB provided services for companies at every stage of their business, but it was more well-known for its support of startups and venture-backed firms. Forty-four percent of the venture-backed technology and healthcare initial public offerings in 2022 were clients of SVB.
The bank tripled in size between 2019 and 2022. The COVID-19 pandemic was good for technology companies as consumers spent heavily on digital services and electronics. As a result, the bank had a large number of deposits and assets. Some of the deposits were cash, but most of the deposits funded treasury bonds and other long-term debts, which have low returns and minimal risk. When the Federal Reserve (often called the Fed) increased interest rates as a way to slow inflation, SVB’s bonds were a risky investment. Investors were able to buy bonds at higher interest rates and SVB’s bonds declined in value. At the same time, some of the bank’s customers were facing financial problems and many began to take their money out of the bank, resulting in SVB selling some of its investments at a loss. SVB lost $1.8 billion, and that marked the beginning of the end for the bank.
Some experts and politicians believe that SVB’s failure can be traced to the rollback of the Dodd-Frank Act, which was the major banking regulation that was put into effect in response to the fiscal crisis of 2008. Under Dodd-Frank, banks with more than $50 billion in assets would be subject to additional oversight. However, in 2018, the Economic Growth, Regulatory Relief, and Consumer Protection Act, increased the threshold to $250 billion. The act was signed into law by President Donald Trump.
Overview
The collapse of SVB can be attributed to two major factors: a lack of diversification and a bank run, where customers simultaneously withdrew their deposits. SVB invested many bank deposits into long-term treasury bonds and agency mortgage-backed securities. The bonds and treasury values would fall when interest rates increased. When the Federal Reserve hiked interest rates in 2022 to counter inflation, SVB’s bond portfolio started to drop. SVB would have recovered its capital if it held those bonds until their maturity date.
When economic problems hit the tech sector, many bank customers withdrew money as venture capital started drying up. SVB did not have the cash on hand to liquidate these deposits because they were tied up in long-term investments. They started selling their bonds at a significant loss, which caused distress to customers and investors. In response, people feared the bank was short on capital. Word spread quickly on social media accounts such as Twitter and WhatsApp, inducing panic that the bank did not have enough funds. Customers started to withdraw money. Some said that Twitter fueled the bank run.
Unlike clients of personal banking, SVB’s clients generally had much larger accounts. It did not take long for money to diminish during the bank run, with the escalating pace of withdrawals causing a snowball effect. Most customers had deposits more than the $250,000 Federal Deposit Insurance Corporation limit. Many startups left money in their SVB primary account instead of using other accounts, such as a money market, to pay expenditures. This means most of their working capital was in their SVB account, and they needed access to their deposits for payroll and bills. There is an additional safety net in which the Federal Reserve made all the depositors whole and went above the $250,000 threshold. Federal authorities decided to protect all of SVB’s deposits because of a fear of what the bank’s collapse could have on the economy as a whole. The FDIC estimated that the cost of the failure of SVB to it would be about $20 billion.
Individual taxpayers were not overly affected by this; a special assessment is made on banks that pay into this account, so it was actually funded through a charge on other financial institutions. Investors will not benefit from the FDIC funding. While the FDIC can protect depositors from losses, it cannot do the same for shareholders and unsecured debt holders. Individuals and institutions that owned stock in SVB Financial Group may not get their money back. However, that does not mean that banks will not pass along increases when the bank has to pay more for deposit insurance. This may take the form of a higher interest rate on a loan or a lower percentage of interest in a savings account.
In a report issued in April 2023, the Federal Reserve formally attributed blame for the bank’s failure to SVB’s senior management team for mismanaging the investment risk of their balance sheet as well as the board of directors for not performing their duty as a check on senior management. The Fed also took some blame for its own officials not recognizing concerns as the SVB grew so quickly between 2019 and 2021. The Fed cited the 2018 change in Fed supervisory standards and the impact of social media with a highly networked and concentrated depositor base as contributing factors. SVB did not have enough intervention from Federal Reserve supervisors who took too long to deal with problems they were aware of and missed other ones that should have been easily recognizable, the Fed said in its report. “Federal Reserve supervisors failed to take forceful enough action,” said Michael Barr, the central bank’s vice chair for supervision, who authored the report. “SVB’s failure demonstrates that there are weaknesses in regulation and supervision that must be addressed.”
The collapse of SVB led to the failure of another major lender, Signature Bank, which was shuttered after depositors withdrew large sums of money. Regulators closed the bank in an effort to calm the panic in the banking industry. More than 550 banks shut down from 2001 to the summer of 2023, according to the FDIC. But Signature’s breakdown stands out because of its connection to the SVB failure and ensuing fears about the health of the banking sector as a whole. At the time, SVB was the biggest bank failure—and Signature the second biggest—since Washington Mutual closed in 2008.
Those collapses have since been outdone by the failure of First Republic Bank in April 2023. Most of that bank’s business was sold to JPMorgan Chase after being seized by federal authorities. Like SVB and Signature, First Republic faced a run on deposits. As of December 2022, about 67 percent of First Republic’s deposits were uninsured, according to S&P Global Market Intelligence data analysis. First Republic customers with uninsured funds became nervous after the shutdowns of SVB and Signature.
Bibliography
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