March 21, 2023/United Capital Research
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Silicon Valley Bank Crisis
Earlier in the month, the California Department of Financial Protection and Innovation (DFPI) announced the shutdown of Silicon Valley Bank (SVB, or the Bank) a financial institution that provides banking services to nearly half of the United States (US) venture capital-backed technology and life-science companies. Generally, the Bank’s collapse was ascribed to poor risk management. This makes it the largest bank to fail since 2008 financial crisis.
As of December 2021, SVB had total assets of $211.3bn, with $125.8bn in non-interest-bearing demand deposits and $63.4bn in interest-bearing deposits. In 2022, the Bank’s asset base increased by 0.2% y/y to $211.8bn. During the same period, the Bank’s non-interest-bearing demand deposits decreased by 36.0% y/y to $80.8bn, while interest-bearing deposits rose by 46.0% to $92.4bn. This change in the Bank’s liability holdings indicates that SVB has more work to do in servicing the significant increase in interest-bearing deposits.
Obviously, SVB invested in long term debt securities whose Hold-To-Maturity (HTM) were ten years and above while taking on Venture Capitalists’ (VCs) depository funds. The Bank failed to consider the dynamics of the global macroeconomic environment with rising inflationary pressure in the US. In 2022, the Federal Reserve hiked interest rates to combat elevated price pressure in the economy. Thus. Depository funds started to decline as VCs pulled back and slowed down their pace of dealmaking. This resulted in liquidity issues and the Bank sold off some of its assets, albeit at a loss.
Before the collapse, the Bank dealt with circumstances such as the threat of a credit rating downgrade, the need to raise additional capital and liquidity, and a balance sheet heavy with unrealised losses. In resolving the issues, the management team sought to sell “substantially all” of its Available For Sale (AFS) securities portfolio at a $1.8bn after-tax loss. In addition, the Bank planned to shore up its balance sheet by raising approximately $2.3bn between common equity and mandatory convertible preferred shares. However, SVB never raised fresh capital as depositors had withdrawn their funds, and the Bank had a negative cash balance of $958.0mn. This led to a major solvency issue for SVB.
In response to the Bank’s collapse, the Federal Deposit Insurance Corporation (FDIC) was appointed to take on depositors’ funds. In addition, the US Treasury and Fed assured that depositors’ funds would be fully protected and paid in full. Lastly, HSBC has acquired SVB UK to enable UK customers to continue their banking activities while ensuring their deposits are safely and fully backed. However, one of the downside risks of the Bank’s collapse is the possible contagion risk effect, as evidenced by the recent closure of Signature Bank, marking the third-largest failure in US banking history.
Mistakes of Silicon Valley Bank
Poor Risk Management
The major reason for the collapse of SVB was because the Bank had poor risk management. The Bank failed to consider the dynamics of the global macroeconomic environment with rising inflationary pressures in the US, while investing in long term fixed income assets. In the same vein, SVB failed to manage its interest rate risk by refusing to hedge its exposures against possible interest rate hikes and related “red flags” that may arise as the FED combats elevated inflationary trend.
Mismatch of assets and liabilities was another reason for the collapse of SVB. Majority of the Bank’s deposits were short termed; hence, the Bank was expected to deposit these inflows with the Fed or invest in short term instruments like T-bills etc. Conversely, SVB invested the short tenured deposits in long term fixed income securities, hence causing an asset-liability mismatch.
High Reliance on Uninsured Deposits
Almost 97% of the deposits at the SVB were from customers with more than $250,000 limit set by the FDIC. The flip side of this is that uninsured depositors are more likely to run (thus, making the bank inherently unstable) once there is an issue with a financial institution as evident in the case of SVB.
Regulatory and Supervisory Failure
Looking at the regulatory and supervisory oversight functions of the FED and related regulators, one could partly attribute the failure of SVB to poor regulatory and supervisory oversight. The Fed supervised SVB from head to toe, with the San Francisco Federal Reserve Bank in charge of both the Bank and its larger parent holding company. However, the FED was unable to sight, ring the warning bells and address the red flags emanating from the operations of SVB.
Lessons Learnt from Silicon Valley Bank
Proper Risk Management System
Banks and other financial institutions should maintain proper risk management system. The dynamics of both domestic and global macroeconomic indicators should be properly factored into their day-to-day activities and map out sound strategies for hedging against seen and unforeseen headwinds.
Proper Matching of Assets and Liabilities
Assets and liabilities should be properly managed across board. Short-term and long-term exposures should be properly matched with corresponding investments. Similarly, depositors ’funds should be properly insured in case of unforeseen and unavoidable run on the company.
Stricter Regulatory and Supervisory Oversight
Regulators should create rules aimed at preventing the collapse of financial institutions. Similarly, the supervisory function of regulators which targets compliance and enforcement of rules should be stricter to avoid similar occurrences.
Possible Fintech Companies Affected by the SVB’s Collapse
The collapse of Silicon Valley Bank will primarily affect the global tech and banking ecosystem. On Nigerian tech start-ups, the impact of the collapse will be minimal as the Bank does not directly transact with African startups. Though, there may be few instances of direct or indirect investment of funds. Based on this, the exception will be tech start-ups with funds trapped in SVB due to direct or indirect investment. For example, Chipper Cash disclosed in a statement that about $1.0mn of its funds is trapped in SVB. The fintech company, one of Africa’s most valuable startups, said SVB was one of its investors and had led its Series C fund raise.