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Move Fast and Break Things: Banking Edition

Updated: May 7, 2023

Parmin Sedigh, finalist of the Ontario Writing Workshop

April 1st, 2023

 


Silicon Valley Bank (SVB) was the sixteenth largest bank in the United States. And then it wasn’t.

On Wednesday, March 8, SVB announced that it was seeking $2.25 billion in additional money (through selling stocks) to continue running the bank (Silicon Valley Bank). This served as a fire alarm for venture capitalists — investors who invest in startups in exchange for part-ownership of the company — and other depositors who had money in the bank (Clarine). What ensued was a phenomenon known as a bank run (Giang). Everyone was suddenly withdrawing their money from SVB out of fear and SVB didn’t have enough cash on hand to meet this demand, resulting in its collapse. But why didn’t they have that cash? In order to make a profit, banks invest the money people or companies deposit in their bank into various assets. One of the most reliable and popular assets for this are U.S. treasuries (Cussen). These treasuries come in different forms depending on how long it takes for the government to pay back the lender. Treasuries involve lending the government money with the promise that the lender will get their money back with some profit. This profit depends on the market interest rate — a rate mostly decided on by the central bank of a country — at the time of purchasing the bond (Cussen).

The central bank, called the Federal Reserve in the U.S., changes the interest rate depending on the state of the economy. If they believe the economy is overheating (meaning the economy is operating at a level beyond what it sustainably should be doing) and inflation is running rampant, the Federal Reserve will raise interest rates to cool down inflation. This is exactly what occurred starting in March 2022 (Cox). For the first time since 2018, the interest rate was increased due to extreme inflation. This increase had many effects on the economy, some desirable and others not so much, but the effect that was most important to SVB was the change for treasuries.

This is because bond prices (bonds are a type of treasury) and interest rates have an inverse relationship — higher interest rates mean lower bond prices (Luthi). Before 2022, interest rates were at historically low levels, and SVB bought most of its bonds at that time. However, the recent rise in interest rates had made bonds bought before 2022 an undesirable investment for banks. Bonds being issued today are able to get higher returns from the

government due to higher interest rates (Luthi). This means that if SVB wanted to sell the bonds it had bought in 2020, for instance, it would have to sell them at a discount to attract buyers who could instead go directly to the government and buy higher-return bonds (Luthi). One aspect that makes bonds so appealing is the fact that investors can simply wait until the bond matures (or

reaches an agreed-upon date) and get back the money they invested, not losing anything in the process (Cussen).

In fact, this issue with bonds may not have resulted in SVB’s collapse had it not been for a second factor: the downturn in the technology sector. In recent months, Big Tech companies as well as startups have seen large decreases in their funding and revenue, resulting in mass layoffs and what some are calling a sector-specific recession (Lowrey). The downturn in tech has its

own set of complex reasons, many of which also involve increasing interest rates, which are beyond the scope of this article.

Returning to SVB, this tech “recession” resulted in people and companies who had put their money into SVB (called depositors) suddenly withdrawing it as they no longer had other money flowing in. Coupled with SVB’s announcement on March 8 that it was seeking additional capital, this sent depositors into a frenzy, causing the aforementioned bank run and collapse. Some sources say that only a few dozen venture capitalists were responsible for the sudden withdrawals from SVB. Peter Thiel’s venture capital fund called Founders Fund reportedly withdrew millions of dollars from the bank and instructed their companies to do the same (Chapman). This highlights the concentration risk SVB had put itself under. Larger banks like J.P. Morgan and Bank of America have a very diverse group of depositors from various sectors (Swisher). However, SVB was openly concentrating its efforts in the startup and venture capital world, offering benefits as diverse as customized banking solutions to networking opportunities. In fact, SVB was so focused on the startup world that, according to their website, “50% of US venture-backed tech and life sciences companies bank[ed] with SVB” (Silicon Valley Bank).

To sum up SVB’s collapse, Charles Forelle, financial editor at the Wall Street Journal, calls it a twin problem — rising interest rates combined with sudden withdrawals due to the tech and startup downturn led to SVB’s demise. That begs the question: What’s next? Since SVB’s collapse on Friday, March 10, much has happened both in the U.S. and across the world (as SVB has branches in other countries) in terms of the market reaction and reactions by governments to help depositors.

In the U.S., the Federal Deposit Insurance Corporation (FDIC) has stepped in and taken over SVB in an effort to return deposits to depositors (The Peak). The FDIC was founded during the Great Depression and has the goal of insuring depositors’ money in banks. Normally, the FDIC only insures $250,000 per deposit holder. This means that if a bank collapsed, anyone who had less than $250,000 in that bank would get it back from the FDIC. Where does the FDIC get this money? In order for a bank to get FDIC insurance (which banks do to legitimize themselves), they must pay a certain amount which creates a sum of money the FDIC sets aside until it becomes necessary to use. $250,00 is certainly a lot of money for an individual; the problem was that SVB’s depositors were mainly companies who had far larger sums in their accounts, with a reported 93% of SVB depositors not being FDIC-insured due to this reason (The Peak).

However, in a somewhat surprising move, on Sunday, March 12, the Treasury, Federal Reserve, and FDIC released a joint statement saying that all depositors from SVB will be made whole, meaning they will receive all of their money regardless of the $250,000 limit starting Monday, March 13 (Federal Reserve Board). Additionally, they stated that while depositors will receive their money, investors and management will not be recouped.

This seemed to be a largely happy ending, but the economy is very complex. The Federal Reserve, for instance, is more unsure than ever about raising interest rates again. Testifying in front of Congress days before SVB’s collapse, Jerome Powell, the Federal Reserve Chairman, implied heavily that the Federal Reserve was going to continue raising interest rates (Wallace). Now, Goldman Sachs, one of the largest U.S. banks has said that they do not expect the Federal Reserve to increase rates at their next March meeting, a far cry from what analysts were saying prior to the SVB collapse (Lee).

On top of this, many are worried about systemic risk — will this collapse spread to other banks too? Some who lived through the 2008 financial crisis can’t help but get a feeling of deja-vu. Analysts believe the banking system is safe for now, but the collapse of two other banks over the past few days — Silvergate and Signature Bank — highlights that there are other banks in risky positions (Chittenden, Sigalos). Admittedly, both of these banks worked closely with the cryptocurrency sector, another sector that has been experiencing severe problems.

Zooming out of the U.S. and into Canada, what could this mean for the Canadian banking system? Over the past five days as the demise of SVB has been unfolding, the five largest

Canadian banks — RBC, TD, Scotiabank, BMO, and CIBC — have all seen drops in their stocks, showing lower investor confidence which is to be expected (CBC). Karl Schamotta, chief market strategist with Corpay, explained in an interview with CBC that “investors need to brace themselves really, for a very turbulent period ahead.”

As well, the Superintendent of Financial Institutions in Canada has taken temporary control of SVB’s assets in Canada as SVB had a branch in Toronto (OSFI-BSIF). However, SVB did not work with individual Canadian depositors and instead focused mainly on “lending to corporate clients” (OSFI-BSIF). This means the Canadian banking system is not at great risk due to SVB’s collapse, at least according to what economists know for now.

All in all, SVB’s demise is sure to continue sending ripples throughout the banking and financial systems worldwide for weeks to come. It seems that all is calm for now thanks to quick actions by governments across the world. Yet with new interest rate increases having been challenged and the second-largest banking failure in American history occurring last week, economists are vigilant about the future. SVB moved fast and broke many things — as the common Silicon Valley saying goes. Let’s all hope they didn’t leave irreparable damage in their wake.

 

Works Cited

“Canada, other governments hustle to stop Silicon Valley Bank crisis from spreading.” CBC, 13 March 2023, https://www.cbc.ca/news/business/silicon-valley-bank-us-uk-1.6776860. Accessed 14 March 2023.

Chapman, Lizette. “SVB Collapse: Peter Thiel's Founders Fund Withdrew Millions.” Bloomberg.com, 11 March 2023,

https://www.bloomberg.com/news/articles/2023-03-11/thiel-s-founders-fund-withdrew-m illions-from-silicon-valley-bank#xj4y7vzkg. Accessed 14 March 2023.

Chittenden, William. “Analysis: What Silicon Valley Bank collapse means for the U.S. financial system.” PBS, 13 March 2023,

https://www.pbs.org/newshour/economy/analysis-what-silicon-valley-bank-collapse-mea ns-for-the-u-s-financial-system. Accessed 14 March 2023.

Clarine, Skylar. “Venture Capitalists Definition: Who Are They and What Do They Do?” Investopedia, 31 May 2022, https://www.investopedia.com/terms/v/venturecapitalist.asp. Accessed 14 March 2023.

Cox, Jeff. “Federal Reserve approves first interest rate hike in more than three years, sees six more ahead.” CNBC, 16 March 2022,

https://www.cnbc.com/2022/03/16/federal-reserve-meeting.html. Accessed 14 March 2023.

Cussen, Mark. “Introduction to Treasury Securities.” Investopedia, 9 July 2022, https://www.investopedia.com/articles/investing/073113/introduction-treasury-securities. asp. Accessed 14 March 2023.

Fertoli, Annmarie, and Charles Forelle. SVB Collapses, in Second Largest Bank Failure in U.S. History. Wall Street Journal, 10 March 2023,

https://www.wsj.com/podcasts/whats-news/svb-collapses-in-second-largest-bank-failure-i n-us-history/c8c6c3a2-ba0a-47ed-a38f-3f958cdcfffb.

Giang, Vivian. “Silicon Valley Bank and Signature Collapses: What We Know.” The New York Times, 14 March 2023,

https://www.nytimes.com/article/svb-silicon-valley-bank-explainer.html. Accessed 14 March 2023.

“Joint Statement by Treasury, Federal Reserve, and FDIC.” Federal Reserve Board, 12 March 2023,

https://www.federalreserve.gov/newsevents/pressreleases/monetary20230312b.htm. Accessed 14 March 2023.

Lee, Jihye. “Goldman Sachs no longer expects the Fed to hike rates in March, cites stress on banking system.” CNBC, 13 March 2023,

https://www.cnbc.com/2023/03/13/goldman-sachs-no-longer-expects-the-fed-to-hike-rate s-in-march.html. Accessed 14 March 2023.

Lowrey, Annie. “How Did Tech Become America's Most Troubled Industry?” The Atlantic, 22 January 2023,

https://www.theatlantic.com/ideas/archive/2023/01/tech-recession-layoffs-google-facebo ok-microsoft/672798/. Accessed 14 March 2023.

Luthi, Ben. “Why Do Bond Prices Go Down When Interest Rates Rise?” The Balance, 8 December 2022,

https://www.thebalancemoney.com/why-do-bond-prices-go-down-when-interest-rates-ris e-2388565. Accessed 14 March 2023.

McColl, Bill. “SVB Financial Group Shares Crater on Stock Sale Announcement.” Investopedia, 9 March 2023,

https://www.investopedia.com/svb-financial-group-shares-crater-on-stock-sale-announce ment-7253409. Accessed 14 March 2023.

Sigalos, MacKenzie. “Signature, SVB, Silvergate failures: Effects on crypto sector.” CNBC, 13 March 2023,

https://www.cnbc.com/2023/03/12/signature-svb-silvergate-failures-effects-on-crypto-sec tor.html. Accessed 14 March 2023.

“Silicon Valley Bank goes kaputt.” The Peak, 11 March 2023,

https://www.readthepeak.com/stories/03-23-silicon-valley-bank-goes-kaputt. Accessed 14 March 2023.

“Superintendent of Financial Institutions takes temporary control of Silicon Valley Bank's Canadian branch.” OSFI-BSIF, 12 March 2023,

https://www.osfi-bsif.gc.ca/Eng/osfi-bsif/med/Pages/nr20230312.aspx. Accessed 14 March 2023.

“SVB Startup Banking.” Silicon Valley Bank,

https://www.svb.com/how-we-help-clients/startup-banking-b. Accessed 14 March 2023. Swisher, Kara, Galloway, Scott, and Cohan, William. Silicon Valley Bank’s Downfall. Pivot, 12 March, 2023, https://podcasts.voxmedia.com/show/pivot.

Wallace, Alicia. “Takeaways from Powell's congressional testimony.” CNN, 7 March 2023, https://www.cnn.com/2023/03/07/economy/powell-congressional-testimony-inflation/ind ex.html. Accessed 14 March 2023.

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