Silicon Valley Bank of SVB Financial (SIVB) is shutting down in the biggest bank failure since the global financial crisis with total assets and deposits equaling $212 billion and $173 billion, respectively. Even worse, the collapse is the second bank to shut down this week following Silvergate’s (SI) collapse.
The development has led to fears of a contagion spreading across the financial system with the obvious extreme parallel being the Lehman Brothers crash that helped kick off the global financial crisis. However, there are some major reasons why SVB and Silvergate shutting down will likely be contained only to a relatively small group of institutions.
Why Did Silvergate and SVB Fail?
Silvergate and Silicon Valley Bank didn’t cater to exactly the same crowd but served as a major bank to similar situations. Silvergate focused on cryptocurrencies and thus saw massive success and its shares surge in 2021 when all things blockchain were at a peak as investors ate up every new crypto project and NFT sale. Meanwhile, SVB prioritized venture capital firms and tech startups that saw extreme growth in 2021 as tech stocks remained hot and low interest rates helped keep the good times flowing.
Inflation and the resulting high interest rates from the Federal Reserve to combat price pressures have since led to a massive drop in speculative trading in the likes of cryptocurrencies and tech startups. The Fed reiterating its intention to push rates higher recently has only furthered that drop in more risky investments as the central bank focuses on getting inflation under control.
With cryptocurrencies and newer tech companies already struggling for more than a year now, there was already a natural draw on deposits from these two banks before this week’s run. Struggling companies don’t generate a lot of cash, and new funding has largely dried up with rising rates. This means that both the VC firms and the startups that kept deposits at SVB were drawing down deposits at the bank to keep operating.
Meanwhile, SVB. which grew incredibly fast over the last several years, had parked that cash in longer-dated Treasuries and mortgage-backed securities that have lost value with rising rates. Meaning that when they couldn't sell those assets for what they paid for them. Which is how a liquidity problem (not enough cash on hand) becomes a solvency problem (more liabilities than assets).
For Silicon Valley Bank, the situation was not helped at all by Peter Thiel’s Founder’s Fund which advised companies to withdraw from the bank as concerns mounted over SVB’s financial stability. SVB had already announced on Wednesday that it was looking to raise more than $2 billion in capital following a $1.8 billion loss on asset sales.
What it Means for the Market
Most other banks SHOULDN’T have similar problems as long as they don’t have a similar concentration of depositors in industries with high cash burn that aren’t exactly doing that hot right now. The banking system at large should be diversified enough on the deposit side that the issue is contained. Some other bad apples may be weeded out and some others will deal with higher withdrawals from rising fears, but not enough to lead to insolvency.
An interesting aspect that analysts are pointing out is that banks will likely now compete harder for deposits given the situation and thus raise deposit rates to be competitive with both each other and alternative places to park cash. The higher rates will then naturally come at the expense of margins and see banks not be as profitable with higher rate offerings and reserves in case of emergency.
Another factor is that over 90% of venture capital firms and tech startups that used SVB were apparently over the FDIC insured limit of $250,000. Meaning that the first $250,000 of deposits is insured by the Federal Deposit Insurance Corporation but anything after that is not guaranteed. This means that there could be a contagion amongst venture capitalists and tech startups that need the cash, but will have to wait to see how much more than the insured $250,000 they will get.
SVB and Silvergate aren’t Lehman Brothers, but the ripple effects of these collapses aren't over yet.