LondonFinance1
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Management Consulting
You might have seen the news about the collapse of Silicon Valley Bank https://www.uktech.news/funding/bank-finance/silicon-valley-bank-collapse-uk-tech-20230310, its rescue and the fire sale of the bank’s UK operations to HSBC https://news.sky.com/story/hsbc-buys-silicon-valley-bank-12832697. But what is this all about? Are we heading straight into another financial crisis? After all it was the biggest collapse since 2008 with $212bn of assets https://www.economist.com/leaders/2023/03/13/what-really-went-wrong-at-silicon-valley-bank.
Let’s take a step back: Silicon Valley Bank was also known as the “start-up bank” due to its location which brought a somewhat special client base, but also served a range of other customers. A lot of these clients held deposits of more than $250,000 /the maximum insured by the US federal government. Once word spread about SVB’s troubles, they withdrew their deposits to be in the safe side. On the asset side, SVB held a lot of long-term bonds on its books, basically a huge unhedged bet on interest rates staying low for a long time. As we all know that did not happen, so the bet went wrong: raising interest rates in the past 12-18 months meant that the value of the bonds in the SVB’s books fell (as they carry fixed interest from the near-zero days, they are comparatively less attractive than bonds issued now which carry higher interest rates; if a bond carries interest rates below the rate of inflation, you will basically lose money, so selling it now will only work at a discount). That also meant that they were not easy to sell, putting a strain on the bank’s liquidity. That meant that even while clients would have been able to get all of their assets back, it might have taken a while, time that start-ups might not have (every finance person in a start-up can give you the exact date when the company at its current run rate will run out of money).
Now, psychology kicks in: if one bank is in trouble, clients of other banks might fear for the safety of their deposits as well. If too many clients want to withdraw their deposits, banks will get into trouble. One of their main jobs is maturity transformation: transform smaller, individual short-term deposits (savings) into larger long-term loans. This saves you asking hundreds of people for a part of their savings if you want to get a mortgage. While everyone in banking is moaning about regulations, it helps to avoid the system getting into disbalance.
The Trump administration abolished quite a bit of these regulations, called the Dodd-Frank Act, which (amongst other things) required banks with more than $50bn in assets to follow a number of new rules after the financial crisis. They were required to write (and keep updated) a plan for their own orderly resolution should they fail. In the worst case, this would allow for a swift and orderly wind down of the bank (usually over a weekend), containing the contagion to the wider banking system mentioned above.
During the Trump years, both the resolution planning and liquidity rules were watered down, especially for banks with $100bn-250bn of assets. There have never been bail-in plans for these banks (i.e. converting debt into equity). SVB tried to recapitalise itself by issuing new shares which takes a lot longer and also happens in public for everyone to see.
So, when the proverbial started to hit to fan, regulators had to improvise which cost even more time and meant that even more clients started to withdraw their deposits, aggravating the bank’s woes. In the end, things got so bad, that a (somewhat) orderly wind-down was not possible anymore. The bank had to be closed.
Now, what does that all mean? Part of this was a good old-fashioned bank run, coupled with risk management that could have been better (accept less customers with large deposits) and a bank making the wrong call on its investments/hedging. But given SVB’s importance for the start-up ecosystem, it will mean that tech capital might become harder to raise for a while. After such an event, the pendulum tends to swing into the other direction (too much), so budding start-ups will come under extra scrutiny. SVB also offered some start-up specific niche products, e.g. on debt financing. This will not be replaced quickly by another bank.
Does all this mean that we are heading into another financial crisis? Not really – if other banks are well (or at least better) managed, a repeat (and thus contagion of the wider system) is unlikely, but regulators (them again) will need to do their jobs properly, so cost of capital will increase slightly/availability for risky investments fall in the short/medium term. You will have seen the reports of Credit Suisse getting into rough waters as well https://www.ft.com/content/85f6768d-0a01-41a3-8925-1c636d3f7dbc CS is a somewhat different story, though, the bank’s liquidity is not its fundamental problem. It is more that its business model is not profitable and this will worsen when more and more of its private banking clients withdraw their funds, so in the end liquidity could become an issue. This is probably worth are separate post.
There was an element of bailing out crypto with SVB, though. After all prices for crypto currencies have rallied after the news https://www.ft.com/content/488d22cb-9aa4-44c8-8961-f2be235a868c (Bitcoin is up by a third over the last seven days) - quite a few crypto companies were banking with SVB and their liquidity was ensured after the bail-out. Some of these companies were exchanges or wallet providers, so the crypto market did not lose liquidity which helped with crypto prices. It can be assumed that SVB’s tech clients are likely to be more likely to hold crypto currency (and if so higher amounts) than the average client of other banks – with their deposits secured, these clients did not have to sell their crypto holdings to pay their mortgages and bills. However, there was no direct bail-out of crypto currencies.
In the end, every bank bail-out brings a problem of moral hazard. Everyone involved will enjoy the upside, but the taxpayer will need to foot the bill for the downside. As onerous as regulations sometimes seem, they protect taxpayers’ money and keep the wider economy stable.
Let’s take a step back: Silicon Valley Bank was also known as the “start-up bank” due to its location which brought a somewhat special client base, but also served a range of other customers. A lot of these clients held deposits of more than $250,000 /the maximum insured by the US federal government. Once word spread about SVB’s troubles, they withdrew their deposits to be in the safe side. On the asset side, SVB held a lot of long-term bonds on its books, basically a huge unhedged bet on interest rates staying low for a long time. As we all know that did not happen, so the bet went wrong: raising interest rates in the past 12-18 months meant that the value of the bonds in the SVB’s books fell (as they carry fixed interest from the near-zero days, they are comparatively less attractive than bonds issued now which carry higher interest rates; if a bond carries interest rates below the rate of inflation, you will basically lose money, so selling it now will only work at a discount). That also meant that they were not easy to sell, putting a strain on the bank’s liquidity. That meant that even while clients would have been able to get all of their assets back, it might have taken a while, time that start-ups might not have (every finance person in a start-up can give you the exact date when the company at its current run rate will run out of money).
Now, psychology kicks in: if one bank is in trouble, clients of other banks might fear for the safety of their deposits as well. If too many clients want to withdraw their deposits, banks will get into trouble. One of their main jobs is maturity transformation: transform smaller, individual short-term deposits (savings) into larger long-term loans. This saves you asking hundreds of people for a part of their savings if you want to get a mortgage. While everyone in banking is moaning about regulations, it helps to avoid the system getting into disbalance.
The Trump administration abolished quite a bit of these regulations, called the Dodd-Frank Act, which (amongst other things) required banks with more than $50bn in assets to follow a number of new rules after the financial crisis. They were required to write (and keep updated) a plan for their own orderly resolution should they fail. In the worst case, this would allow for a swift and orderly wind down of the bank (usually over a weekend), containing the contagion to the wider banking system mentioned above.
During the Trump years, both the resolution planning and liquidity rules were watered down, especially for banks with $100bn-250bn of assets. There have never been bail-in plans for these banks (i.e. converting debt into equity). SVB tried to recapitalise itself by issuing new shares which takes a lot longer and also happens in public for everyone to see.
So, when the proverbial started to hit to fan, regulators had to improvise which cost even more time and meant that even more clients started to withdraw their deposits, aggravating the bank’s woes. In the end, things got so bad, that a (somewhat) orderly wind-down was not possible anymore. The bank had to be closed.
Now, what does that all mean? Part of this was a good old-fashioned bank run, coupled with risk management that could have been better (accept less customers with large deposits) and a bank making the wrong call on its investments/hedging. But given SVB’s importance for the start-up ecosystem, it will mean that tech capital might become harder to raise for a while. After such an event, the pendulum tends to swing into the other direction (too much), so budding start-ups will come under extra scrutiny. SVB also offered some start-up specific niche products, e.g. on debt financing. This will not be replaced quickly by another bank.
Does all this mean that we are heading into another financial crisis? Not really – if other banks are well (or at least better) managed, a repeat (and thus contagion of the wider system) is unlikely, but regulators (them again) will need to do their jobs properly, so cost of capital will increase slightly/availability for risky investments fall in the short/medium term. You will have seen the reports of Credit Suisse getting into rough waters as well https://www.ft.com/content/85f6768d-0a01-41a3-8925-1c636d3f7dbc CS is a somewhat different story, though, the bank’s liquidity is not its fundamental problem. It is more that its business model is not profitable and this will worsen when more and more of its private banking clients withdraw their funds, so in the end liquidity could become an issue. This is probably worth are separate post.
There was an element of bailing out crypto with SVB, though. After all prices for crypto currencies have rallied after the news https://www.ft.com/content/488d22cb-9aa4-44c8-8961-f2be235a868c (Bitcoin is up by a third over the last seven days) - quite a few crypto companies were banking with SVB and their liquidity was ensured after the bail-out. Some of these companies were exchanges or wallet providers, so the crypto market did not lose liquidity which helped with crypto prices. It can be assumed that SVB’s tech clients are likely to be more likely to hold crypto currency (and if so higher amounts) than the average client of other banks – with their deposits secured, these clients did not have to sell their crypto holdings to pay their mortgages and bills. However, there was no direct bail-out of crypto currencies.
In the end, every bank bail-out brings a problem of moral hazard. Everyone involved will enjoy the upside, but the taxpayer will need to foot the bill for the downside. As onerous as regulations sometimes seem, they protect taxpayers’ money and keep the wider economy stable.
