By Antonio Graceffo
There has been no bailout for Silicon Valley Bank (SVB). The bank went into receivership administered by the FDIC, which has pledged to make depositors whole. SVB as a company has ceased to exist and its shareholders have lost their investment.
SVB was founded in 1983 to provide services and funding to tech startups. With $209 billion in total assets, it was among the top 20 American commercial banks and it has provided financing for nearly half of US venture-backed technology and healthcare companies. This means that SVB was heavily exposed to these two sectors, and the success or failure of the bank would be strongly correlated with movements in tech and healthcare.
The short explanation of what happened to SVB is that it was hit by a run on the bank. Due to the fractional reserve banking system used in the United States and other countries, if every depositor decided to withdraw their money on the same day, the bank would run out of funds. Only a small percentage of all deposits are held in a bank. The rest are loaned out, and this is how banks earn money.
To understand why depositors and investors began pulling their funds out of SVB, a more detailed explanation is necessary.
Tech is a heavily leveraged sector, where companies tend to borrow a lot of money. The funds are used for research and development in the hopes of making a killing once products are brought to market. Consequently, SVB was exposed to tremendous credit risk, and then two events occurred simultaneously: The tech sector went into decline and the Fed raised interest rates.
SVB borrowed short and lent long, meaning that as interest rates were rising, the bank was having trouble making its interest payments. When the deposit base began to dissipate, SVB was unable to meet its obligations.
SVB’s bond portfolio, valued at $21 billion, was yielding an average of 1.79%. Meanwhile, after Fed rate hikes, the 10-year treasury yield was about 3.9%. Essentially, SVB was earning less than it was costing it to borrow money. At the same time, venture capital investors became more cautious. With less venture capital flowing in, companies in need of funds began drawing down on their SVB deposits.
Hoping to free up some cash, SVB announced on March 8 that it was selling a large amount of securities at a loss, as well as selling $2.25 billion in new shares. The news spooked investors and depositors who began withdrawing their funds at an accelerated rate. Within 24 hours, SVBs shares had crashed, and the following morning, trading was halted.
In most cases, bank deposits up to $250,000 are insured by the FDIC. But this only applies to FDIC-insured banks, and not to other types of savings or investing institutions. Additionally, it only applies to covered accounts including checking and savings, time deposits such as CDs, Money Market Deposit Accounts and possibly others.
It’s important that the institution is covered by FDIC and if the account itself is covered before opening an account. For example, investment accounts, stocks, bonds, or mutual funds even at commercial banks are not covered. Luckily, SVB was an FDIC-insured bank.
FDIC has two functions. It acts as the insurer of the bank’s deposits, and in the event of a bank failure, it plays the role of “receiver”, collecting and selling the assets of the failed bank and paying off its debts, including deposits in excess of the insurance limit.
On March 13, all SVB’s deposits, both insured and uninsured, were transferred to the FDIC. And a full-service FDIC-operated “bridge bank” was created to provide normal banking services to SVB’s account holders.
It seems unlikely that the collapse of SVB will spread through the broader financial and banking industry and cause another 2008-style global financial crisis. This time around, banks are better insulated against that type of contagion and interest rates are already high.
However, the collapse does raise alarm bells. It encourages closer scrutiny of financial institutions heavily dependent on a single sector of the economy. Additionally, as interest rates rise, small banks borrowing short and lending long will incur greater risk.
This article originally appeared in Highbrow Magazine on March 21, 2023
