You’ve already seen the news. Silicon Valley Bank (SVB) has failed, the second largest American bank in history. Early in the pandemic, SVB assets grew at a prodigious rate. SVB invested in low-yield bonds, which became devalued when the fed hiked interest rates to combat inflation in the wake of the pandemic. This normally wouldn’t be a problem, except SVB ran into liquidity trouble that forced them to sell many of those bonds. This forced them to realize losses of approximately $1.8 billion to cover withdrawals by a now-struggling tech industry finding it more expensive to acquire debt. SVB sought investment to shore up losses, and sparked a panic run on their bank as tech companies, high-net-worth individuals, and notably Peter Thiel’s Founders Fund rushed to withdraw their money to the point of insolvency, sealing SVB’s fate.
New York-based Signature Bank failed days later, the third largest bank closure in American history. Already on shaky ground after a bad bet on cryptocurrency, in the wake of the SVB collapse, investors and depositors alike felt exposed as Signature’s stock price dipped, prompting depositors to move billions of uninsured dollars to larger banks and forcing the FDIC to seize control. In a bit of disturbing irony, former democratic congressman Barney Frank, of the bank-regulating Dodd-Frank Act, was a board member of Signature Bank.
What happened, and how will it impact entrepreneurship in the short term?
Special Thanks to Professor Scott Baker
To ensure we’re providing accurate information and fairly explaining what it all means for entrepreneurs, we reached out to experts for help crafting this piece. Much of that help came from Scott Baker, Associate Professor of Finance at Northwestern University’s Kellogg School of Management. He is also a research fellow at the National Bureau of Economic Research, and has a PhD in Economics from Stanford University.
Didn’t We Just Go Through This?
A handful of American banks fail most years in the wake of the 2008 crisis, usually smaller banks that don’t create large ripple effects across the wider economy. We last saw a large bank fail during the 2008 financial collapse, when Washington Mutual went bankrupt after panicked depositors withdrew 16.7 billion dollars over a 10-day run on the bank. Federal legislators passed the Dodd-Frank Act in 2010, which was supposed to strengthen walls between investment banking and commercial banking (much the way the Glass-Steagall Act once did), and subject “systemically important financial institutions” (SOFI) banks to stress testing and higher prudential standards, with the goal of protecting everyday working people’s savings from risk.
In May of 2018, after much lobbying, many regulations in Dodd-Frank were relaxed for all but the largest banks in a bill led by Republicans that passed with bipartisan support in the house. While most Dodd-Frank regulations, standards, and stress testing previously applied to SOFI banks with $50 billion or more in assets, the new legislation increased that threshold to $100 to $250 billion or more for major provisions. This largely limited Dodd-Frank to regulating the 10-12 largest banks in America (and exempting both SVB and Signature Bank from much of the law).
It’s important to note that SVB wasn’t taking on wild risks or making reckless bets on companies that failed (compared to the extensive cryptocurrency assets at Signature Bank). SVB invested in federal treasury bonds, which are traditionally very safe places for banking assets, only devalued because of sudden large rate hikes. Had the bank still been subjected to Dodd-Frank, increased stress testing might have changed their asset portfolio, encouraged more cash reserves, and avoided the liquidity crunch that sparked a run. However, some experts say interest rate risk stress testing was something of a blind spot in those processes.
Relevant Banking Risks
According to the Treasury Department, there are nine recognized risks banks must mitigate to avoid failure or a hit to depositor confidence that results in a run, three of which are key to understanding the SVB failure and how it differs from 2008:
Loan default/credit risk: If you lend money, and people can’t pay it back at a higher-than-expected rate, the bank loses money. This was a driver of the 2008 collapse, when borrowers defaulted on mortgages that probably shouldn’t have been made, bundled, or rated as highly as they were.
Liquidity risk: When money gets deposited in a bank, the bank only holds a certain percentage in cash reserves. The rest gets loaned out or otherwise invested, to make money so the bank is profitable. Banks need to hold enough cash reserves so everyone banking with them can withdraw money, pay bills, etc. If banks put too high a percentage of their money to work in loans and investments, and don’t keep enough on hand, they might not be able to cover the daily churn of withdrawals (particularly if there’s a spike in withdrawals), sparking panic and a run on the bank.
Interest rate risk: If the fed hikes interest rates, it can devalue existing bond assets for a time. A hike tends to immediately devalue existing treasury bonds. Feds have hiked interest rates some 5 percentage points in recent years in effort to combat inflation. This normally doesn’t matter, because banks can hold those assets long-term until they reach maturity, at which point they can sell them back and see no losses. It only matters if a bank faces an emergency that forces them to sell those devalued bonds to meet a liquidity obligation, such as a period of increased withdrawals. This forces them to realize those losses, which can spark a stock price dip or a run as people lose confidence in the bank.
Does it Really Matter To Me?
As a citizen of these United States, our banking system’s stability and resilience should be of great interest to you. Belief and trust in that system is what ensures you and your customers can deposit, withdraw, and send money around the world quickly and easily. As an entrepreneur, you want easy access to capital, so you can get that loan or a pool of ready investors when you need it. You also want to trust that your own business deposits and withdrawals are reliable. Anything that happens to the financial banking system, be it the investment or commercial banking side of things, matters to you, because entrepreneurs use both.
Should I Change Anything?
There are two areas where this crisis intersects with entrepreneurs—capital access and day-to-day business and personal banking.
Capital Access
Regarding capital access, in a financial climate that just saw two medium-sized banks fail, appetite for risk is expected to cool in at least the short term as banks and venture capitalists wait to see if there are secondary effects or more bank failures, though none are expected. 38% of businesses that fail, fail because of a capital access problem. If your launch or growth plan depends on a bank loan, you might have to look for sources other than bank loans and venture capital, or adjust your timeline. Similarly, venture capital debt is going to be harder to come by, and debt is likely to get a little more expensive.
Banking
As far as day-to-day banking, both personal and corporate, it’s important to note that if your balance rarely or never exceeds $250,000, then you have absolutely nothing to fear. Your money is FDIC-insured so long as your bank is an FDIC-insured entity (which it almost certainly is). If you are at one of the 10 or so largest banks in America, you’re almost certainly fine regardless of deposit amount. If there was a failure at one of those banks, the government would almost certainly define it as a SOFI bank, and make all deposits whole beyond the $250,000 coverage, as it is doing right now with SVB and Signature Bank.
If your balance regularly or always is in excess of $250,000, and you are not at one of the nation’s largest banks (you might even be locked in at SVB as a condition of investment), you are also still probably fine. However, there are a few things you can do to mitigate risk (often at some limitation to liquidity) regarding your balance. You can extend the FDIC insurance coverage by diversifying the number of banks you or your company hold accounts at. There are also a variety of sweep accounts, sometimes referred to ask cash management, CDAR, or MaxSafe accounts, that give you the feel of a single account while actually spreading your money across several banks to multiply the FDIC coverage. There are additional insurance policies you can take out to supplement the FDIC insurance coverage. Exploring some of these options might grant you peace of mind.
Opportunities
The current economic climate has seen many companies, particularly tech companies, lay off significant percentages of their workforce. If you’re positioned to add key tech hires, there is a lot of talent flooding the market right now that you can recruit.
Silicon Valley Bridge Bank is open for business as of March 14th. This is the entity formed by the FDIC to manage SVB assets. Because it is FDIC managed, it is one of the safer banks available. If you were already banking there, and lost access to your accounts for a few days, your money is safe, and you should have access shortly, if not already. If you can manage potential disruptions as the FDIC assumes control and readies the bank for sale, it is a very safe place to stay for the time being. Their need for depositors also means they are likely offering attractive rates.
What Might Happen Next?
While banks failing isn’t typically newsworthy, what’s of note is the size of the asset portfolio for the two banks that failed this month. The $319 billion in combined assets of SVB and Signature Bank approaches the asset value of the 25 failed banks’ $373 billion in assets (primarily the $307 billion held by WaMu) that represented the peak of the 2008 financial collapse. Nearly 300 other banks failed in the two years afterward, representing an additional $267 billion in combined assets.
In that crisis, overvalued mortgage assets and defaults on loans were part of the problem. This time, the challenge is very different, and in some ways, more manageable. So, what might happen next?
Can More Banks Fail?
The FDIC has reported there are over $620 billion dollars in unrealized losses among American banking institutions at present, much of those losses tied to treasury bonds and fed rate hikes, just like SVB. While this, in of itself, is not considered a problem in the financial industry, if a bank faces an emergency and must sell federal bonds to cover withdrawals (which means realizing those losses), they could suddenly find themselves in a similar position to SVB.
Thankfully, the newly launched Federal Reserve Bank Term Funding Program (BTFP) lets banks swap out devalued bonds, erasing the unrealized losses on their balance sheets or helping banks meet unforeseen liquidity needs. This program is backstopped by a $25 billion-dollar Federal Reserve fund. This new program, combined with the Fed cooling on further interest rate hikes should defuse what otherwise might have been a ticking timebomb in our financial system.
Is There Concern of an Overcorrection?
In the current administration of mixed federal government, it’s unlikely federal legislators would be able to impose much in the way of regulations or restrictions on banks, particularly since they appear unwilling to publicly finance a bailout package, unlike 2008. A bailout would offer legislators an opportunity to attach strings to the money. But absent that, this appears to be a fear that is unlikely to be realized regardless of any potential rhetoric. Additionally, while this might become a major campaign issue in the 2024 presidential election, should the crisis pass without further incident, it’s unlikely to motivate voters one way or the other.
In Summary
Two medium-sized banks failed, and the FDIC took over management to make depositors whole and ready the banks for sale. There is minimal concern for escalation at present, as interest rate risk has been alleviated by a new FDIC program to trade out devalued treasury bonds and the Fed has cooled on further raising interest rates. Larger banks have even stepped up to present a united and strong front, as 11 banks invested a combined $30 billion dollars in First Republic Bank to give them enhanced liquidity in the face of a dipping stock price.
However, investigations into SVB and Signature Bank have only just launched, and might reveal information that recolor their causes of failure. This remains a rapidly changing and developing situation, and things could turn, particularly if investor and depositor confidence degrades (which is more subject to perception than reality). Still, most economists expect things to stabilize and move forward without spiraling into widespread banking system failures, though many say odds of a recession have increased.