Silicon Valley’s failure: largest since the 2008 global financial crisis

Silicon Valley Bank (SVB) severely collapsed on March 10, 2023, with regulators seizing control of its deposits, making it the largest bank failure in the US since the 2008 global financial crisis. The bank had been providing financial services to startups, venture capitalists, and other industries in Silicon Valley since 1983. The collapse of SVB was caused by a perfect storm of circumstances, including disappointing financial results, investors selling off the bank’s shares, and a run on its deposits.

SVB had obviously built a solid reputation in the industry by providing banking services to some of the world’s most successful startups, such as Uber, Netflix, and Airbnb. Its core business was lending to startups. The bank’s problems began when its parent company, SVB Financial Group, announced disappointing financial results for the fourth quarter of 2022, which showed that the bank’s loan portfolio had weakened. The bank’s investors began to sell off its shares, causing a sharp decline in the value of the bank’s stock.

At the same time, there was a run on the bank’s deposits, as depositors rushed to withdraw their money. The bank’s liquidity began to dry up, and it was unable to meet its obligations. The California Department of Financial Protection and Innovation closed SVB and named the FDIC as the receiver.

Now, the failure of SVB has had a significant impact on the tech and venture capital community. Companies and wealthy individuals who had money in the bank are now unsure of what will happen to their deposits. The FDIC has created the Deposit Insurance National Bank of Santa Clara, which now holds the insured deposits from SVB. The FDIC’s standard insurance covers up to $250,000 per depositor, per bank, for each account ownership category. The regulator said it would pay uninsured depositors an advanced dividend within the next week, with potential additional dividend payments as the regulator sells SVB’s assets.

However, it is unclear whether depositors with more than $250,000 will get all their money back. The amount of money the regulator gets as it sells Silicon Valley assets or if another bank takes ownership of the remaining assets will determine whether depositors with more than $250,000 ultimately get all their money back. There are concerns in the tech community that until that process unfolds, some companies may have issues making payroll.

The failure of SVB has also underlined the potential securities losses faced by other banks. According to a report, there are 20 banks that are sitting on huge potential securities losses, as was SVB. These banks would face significant losses if they were forced to sell securities to raise cash. The banks on the list have large holdings of asset-backed securities, which are securities backed by a pool of assets such as mortgages or auto loans. If these banks were forced to sell these securities, they would have to do so at a loss, which could have a significant impact on their financial stability.

One of the lessons that can be drawn from the failure of SVB is the need for banks to have adequate risk management systems in place. Banks should have the ability to identify, measure, monitor, and control the risks they face. They should also have a diversified portfolio of assets, which will help to mitigate the impact of losses in any one area. Furthermore, banks should have adequate liquidity management systems in place, which will ensure that they can meet their short-term obligations even during times of financial stress.

Another important element of banking regulation is the requirement for banks to maintain adequate capital reserves. Capital serves as a buffer against unexpected losses and ensures that a bank can absorb losses without becoming insolvent. The amount of capital that a bank is required to hold depends on a number of factors, including the types of assets the bank holds, its risk profile, and the regulations of the country where it operates. Banks are required to maintain a certain level of capital to ensure they have enough funds to cover unexpected losses.

There are several types of capital that banks can hold to meet these requirements, including common equity, preferred equity, and subordinated debt. Common equity is the most important form of capital because it is the most loss-absorbing. This means that if a bank experiences losses, common equity is the first type of capital that is used to cover those losses.

Preferred equity and subordinated debt are also important forms of capital, but they are less loss-absorbing than common equity. Preferred equity is a type of stock that pays a fixed dividend and has a higher claim on the bank’s assets than common equity. Subordinated debt is a type of bond that ranks below other forms of debt in the event of bankruptcy.

In addition to maintaining sufficient capital, banks must also manage their risks effectively. Risk management involves identifying, assessing, and controlling risks that could threaten a bank’s financial stability. Banks use a variety of tools and techniques to manage risks, including diversification, hedging, and stress testing.

Diversification involves spreading a bank’s assets across different types of investments and markets to reduce the impact of any one asset or market on the bank’s overall performance. Similarly, while hedging uses financial instruments, such as derivatives, to offset risks associated with specific investments, stress testing involves simulating various scenarios to assess how a bank would perform under adverse conditions.

The SVB failure is a clear illustration of why banks must prioritize capital and risk management strategies to safeguard their long-term financial stability against potential risks.