Silicon Valley Bank’s collapse explained

With the recent events at Silicon Valley Bank, we’re reaching out to address a few frequently asked questions and to explain the big picture of what’s happening. Because you’re sure to see a wide range of headlines drawing competing conclusions with complicated descriptions, our goal here is to look at things clearly and simply.

What happened at Silicon Valley Bank?

Silicon Valley Bank (SVB), the most prominent bank in the tech industry and the 16th largest bank in the country, collapsed last Friday, leaving many tech firms worried about losing funds they need to make payroll and grow their companies. The collapse seems be driven by a few causes:

Overconcentration in tech

Tech companies have been hit hard by rising interest rates over the last year. These companies often borrow money to grow their business and higher rates make those funds more expensive. Silicon Valley Bank also had a high concentration of venture capital-backed companies who raise new funding from investors based on their current value to fuel growth. When it looks like growth will be tougher going forward, those valuations drop. Rather than raising new investment at a lower valuation, many of these firms drew down their bank balances at SVB. Why is this a problem? This leads us to the next cause.

Liquidity

Banks take customer deposits, called liabilities because they owe them back to you, and invest some of them in loans, bonds, and securities, called assets because they are now producing returns for the bank. These assets are the primary way they make a profit. Banks maintain liquid reserves to ensure customers have access to their funds, but generally all customers do not need all their funds all at once. If withdrawals do exceed the reserve level, the bank may need to sell some of their longer-term investments to meet the withdrawal needs.

This was the case for Silicon Valley Bank. Large, rapid withdrawals forced SVB to sell some of its long-term bonds at a loss, which scared investors and depositors, leading to more withdrawals. As the news circulated Thursday, withdrawal requests exceeded 20% of their total deposits in a single day. To make things even worse, a few prominent venture-capital firms advised their companies to withdraw their deposits, which represented hundreds of companies attempting to move funds all at once, a panic that sent SVB into failure by Friday afternoon.

Will depositors lose their money?

On Sunday, the Federal Reserve and the FDIC, which usually only insures deposits up to $250,000 per individual, announced that they would guarantee all individuals and companies full access to their money. Unlike the bank bailouts we saw in 2008-2009 where government loans were provided to fund banks to keep them afloat, this is more akin to a bailout to those who held deposits at SVB. Silicon Valley Bank is gone, but it looks as though depositors will be made whole. We’ve already seen this news well received by the stock market.

Is this 2008 all over again?

In short, it doesn’t look like it. SVB is the biggest bank failure we’ve seen since 2008, so it makes sense to worry that we’re about to see ripples through the banking system as we did back then. However, things appear to be very different in this case.

In 2008, banks across the financial system carried many interest-only and adjustable-rate mortgages, assuming real estate would only continue to rise and could be refinanced. When real estate prices collapsed, these mortgages couldn’t be refinanced, leaving millions with rate adjustments and payments they couldn’t afford. Banks today don’t have these same kinds of mortgages on the books.

SVB’s collapse looks to be the result of a bank run, where rapid withdrawals exceed reserves out of fear that the bank would become insolvent. While they may have been able to manage reserves and withdrawal requests a bit differently, the call from venture capital firms advising hundreds of companies to move funds all at once made this outcome a near certainty. Had those venture capital firms acted differently, SVB’s failure likely could have been avoided.

What can we learn from Silicon Valley Bank?

Among many lessons that will emerge from Silicon Valley Bank’s collapse, we see three clear financial principles here that we cover in every financial plan:

1. Maintain a well-stocked emergency reserve to meet unexpected expenses. SVB did not have enough reserves to meet their customers’ needs, though banks always carry some risk of large panic-induced withdrawals.
2. Diversify your investment strategy. SVB’s high concentration in tech made them very successful, but also exposed them to significant risk when the industry took a downturn.
3. Keep your bank accounts within the $250,000 FDIC limit per depositor per bank whenever possible. Though the government is stepping in to guarantee deposits beyond the FDIC limit in this case, it’s wise to stay within the standard limit.

We don’t see this as an event that should drive changes to financial or investment strategies, but it serves as an important reminder to make sure your portfolio allocation matches your goals and you’re not overly exposed to a single company or industry. As always, please reach out with any questions! Major shocks like this in the financial worlds can bring anxiety and we’re here to talk through your concerns!