Silicon Valley Bank - what caused the bankruptcy?
The reasons behind SVB failure and its short and long term consequences
Introduction
On Friday 10th of March, Silicon Valley Bank (SVB) became the largest bank to fail since the 2008 financial crisis. This has sparked discussions about the underlying reasons and consequences for banking system and Global economy as a whole. In this article we will review key points of view on why it happened and what could be the consequences.
Key points of view
Reasons behind the failure
Poor investment decisions and lack of risk management
Fraud in not disclosing the underlying risks on time
Consequences
Potential domino effect in the banking system
The impact of SVB collapse will be mitigated
Negative long term effect on startup ecosystem
Nature
Failure of capitalism
Part of capitalism system
Methodology
To cover the topic from different points of view, we explored publications of different groups of stakeholders - financial industry and technology experts, financial authorities and politicians, specialized and mainstream mass media, proponents and opponents of capitalism.
Poor investment decisions and lack of risk management
A common view is that the main reason behind the failure of SVB was the lack of risk management. According to WSJ, Silicon Valley Bank had been buying lots of U.S. Treasurys and government-backed mortgage bonds. This was used to allocate deposits that they got from their clients. When the interest rate was raised by the Federal Reserve in their fight against the growing inflation, the market value of those assets declined sharply which created a potential loss of 17 billions. When concerns about the financial conditions of the bank increased, customers started to withdraw their funds that caused a bank run. This prompted regulators to step in and close the bank. Experts from Guardian and NYT conclude that the collapse of Silicon Valley Bank was caused by a series of ill-fated investment decisions, particularly its heavy investment in long-dated US government bonds, including those backed by mortgages. The bank did not foresee the impact that growing interest rates can have on their financial health and did not manage their risks properly.
Fraud in not disclosing the underlying risks on time
As of now, there are not many allegation of SVB in financial fraud as it was, for example, in the case of FTX. However there are some reports that SVB was hit with its first of what will likely be many securities-fraud lawsuits by shareholders. In accordance with Bloomberg the shareholders believe that Silicon Valley Bank over the last two years failed to disclose the risk that interest rate hikes posed to the bank. The public statements “understated the risks posed to the company by not disclosing that likely interest rate hikes, as outlined by the Fed, had the potential to cause irrevocable damage to the company,” according to the complaint. Reuters and Guardian confirm that the SVB Financial Group and two top executives were sued by shareholders and accused of concealing how rising interest rates would leave its Silicon Valley Bank unit “particularly susceptible” to a bank run. It is expected that as more deep investigation of the situation is conducted, additional allegations might come up.
Potential domino effect in the banking system
While looking at the potential consequences, many experts warn about potential domino effects. Blackrock CEO Larry Fink warns that the failure could simply be the first “domino[es] to drop” before a potential “cascade throughout the U.S. regional banking sector with more seizures and shutdowns coming.” Morningstar agrees that the biggest risk is poised for the regional banks because of their size, complexity, and reliance on market funding and uninsured deposits. They expect that funds will flow out of the regional banks towards the top banks which can create a whole in the regional banks balance sheet. And they also highlight that many other banks have the same problem with the undervalued bonds as SVB which further pressures their financial stability. They conclude that if no timely intervention are made the situation can follow a scenario of 2008 financial crisis.
The impact of SVB collapse will be mitigated
Morningstar also highlights that in order to prevent the potential negative effect on other banks regulators need to push for more capital and higher liquidity levels. US president Joe Biden vowed to do “whatever is needed” to protect bank deposits and said he would seek to “strengthen the rules for banks to make it less likely this kind of bank failure would happen again”. This was followed by the official statement of the Federal reserve that it “will make available additional funding to eligible depository institutions to help assure banks have the ability to meet the needs of all their depositors”. And since the announcement they have already given away more than 300 billions. This measure allows banks to meet all their depositors requests and calm down the market to avoid any other bank runs and bankruptcies.
Negative long term effect on startups ecosystem
Outside of the discussion about the impact of SVB collapse on the banking system and economy in general, some technology experts look specifically at the potential impact on technology industry and startups as SVB worked a lot with startups. Garry Tan thinks that the collapse of SVB would be an “extinction level event for start-ups, [one that could set companies] and innovation back by 10 years or more”. Techcrunch and Wired also highlight that SVB’s failure will have longer-term impacts beyond the next few weeks and months. The collapse of the leading specialist in providing financial services to tech companies could make it harder for the next generation of startups to find what they need to build their business. They highlight that SVB was more than just a bank - it played a critical role in startups funding and helped to fund companies which would not otherwise be funded.
Failure of capitalism
The failure of SVB also intensified the discussion between proponents and opponents of capitalism. Billionaire hedge fund manager Ken Griffin says that the SVB bailout shows ‘capitalism is breaking down’. He thinks that the US government’s decision can lead to “a loss of financial discipline,” “Bailing out uninsured depositors at SVB, which are mostly corporates, further infantilizes markets by sending the message that such risk management is anachronistic.” WSWG writes that the situation with SVB can lead to many people to worry about the safety of their money and can lose their trust in the financial system which can lead to significant consequences. They also highlight the role of existing economic system in the failure. During the Covid pandemic governments were printing and giving away a lot of funds that ended up accelerating inflation. In response to that the governments started to increase their interest rates in order to fight the inflation. And this led to the reduction of value in government bonds that were bought by many banks using the money they got as a result of the money printing.
Part of capitalism system
On the other side, US President Biden says ‘that’s how capitalism works,’. “Investors in the banks will not be protected,” Biden said in a White House speech. “They knowingly took a risk and when the risk didn’t pay off, the investors lose their money. That’s how capitalism works.” Biden’s administration also highlights that they focus on bailing out the clients and not the SVB itself. Others also highlight that in spite of the SVB failure, the main indicators that show the state of capitalism like the creation of new businesses still show that capitalism in the US is working. They also explain that it is an essential part of capitalist systems to face different problems that required the system to adapt. But as a result of such adjustments the system encourage fast innovations and development which would not have been possible otherwise.
Instead of conclusion
The story is still evolving and all the reasons and consequences are yet to be uncovered. We will closely monitor how the situation will evolve.
Liked the article? Subscribe to our newsletter to get weekly article with an overview of different points of view on key subjects and current events!