Silicon Valley Bank: Something Broke

On Monday, I wrote that I would do three days of Insights in response to the Silicon Valley Bank failure.

First, I wrote about how we are protecting your cash in this environment. Next, I wrote about how the bank failure might impact the overall economy.

Today, I’ll try to break down how Silicon Valley Bank (SBV) failed. I’m certain that more details will emerge in the coming days, weeks, and months, so I can only write about what we know now.

The simple answer is that there was an old-fashioned run on the bank: too many depositors wanted their money back simultaneously.

But the underlying problem is deeper than that, starting with the fact that SVB catered to the technology industry. Unlike most banks with a diversified deposit base that includes individuals of all sizes and types of businesses in different sectors, SBV’s deposits were mostly venture capital-backed tech start-ups.

Many of these companies aren’t profitable, meaning they are spending down the cash they’ve raised. Before last year, losing money wasn’t a big deal because these companies were so hot that they could always raise more money.

To bolster its liquidity, SBV started selling some of the bonds that it holds in reserve and raising capital from outside investors. Usually, those two things alone don’t cause a bank run, but this was different for two reasons.

First, the bonds that SVB owned were down from where they bought them. All bond investors lost money last year, and SVB did too. I’ve read conflicting reports about what they bought and how risky their portfolio was, but I don’t know if all of the facts are known here. SVB also failed to raise capital from outside investors.

Those things would have been an issue for any bank, but probably not a full-blown run on the bank, which was the second problem.

The concentrated depositors I mentioned earlier kept balances well over the FDIC limit. They also talked to each other and ultimately decided, en masse, that they needed to get their money out of SBV. All at once. I read that 25 percent of the bank deposits left last Thursday.

There are no banks that are ready for that-sized single-day withdrawal. The regulatory capital rules that banks abide by are not designed for that kind of withdrawal, which was also probably compounded by being able to transfer funds on your phone and a social media frenzy.

Although any bank could have to deal with electronic transfers and social media, most of the other issues are special to SVB: the concentrated deposit base of uninsured customers acting in concert with each other.

That’s why we don’t think this is like the 2008 financial crisis when effectively all of the big banks and financial institutions made bad loans that couldn’t be repaid.

I’m over-simplifying, but hopefully, I’m getting across the basic idea that what’s happening here isn’t the same as what happened in 2008. That doesn’t mean there won’t be more troubling events – there will almost certainly be.

But, as usual, we’re maintaining our diversified approach while keeping a special eye on cash.