Banking crisis unfold
Insights from Silicon Valley Bank's Collapse and Beyond
“Every banker knows that if he has to prove he is worthy of credit, in fact his credit is gone” ~Walter Bagehot
Last week was a wild week which has shaken off the whole financial industry.
Mar 8th 2023: Silvergate Bank - a cornerstone in the crypto world, announced its intent to wind down operations and liquidate the Bank.
Mar 10th 2023: Silicon Valley Bank (SVB), one of the most prominent lenders in the start-up ecosystem, collapsed.
Mar 12th 2023: Signature Bank collapsed. It was the 3rd biggest bank failure in the US, behind Washington Mutual in 2008 and Silicon Valley Bank just 2 days ago.
Mar 15th 2023, First Republic bank was downgraded by S&P and Fitch and became under further pressure. Major US banks inject $30 billion to rescue First Republic Bank to avoid a domino effect of bank collapses.
On the same day, Credit Suisse becomes latest crisis for the sector after its biggest backer said it won’t provide further financial support. Fortunately, on Mar 16th 2023, the Swiss central bank agreed to loan the bank up to 50 billion francs ($54 billion) to bolster confidence in the country’s second-biggest lender.
Never before in our history have we seen a series of bank failures that have so dramatically eroded people's trust in the banking industry. I believe there are still many more vulnerable banks that may not be unfold. In today's blog, we will take a closer look at the collapse of SVB and what lessons we can learn from it.
Looking back at its history, SVB was founded in 1983 and became the 16th largest bank in the United States. It was known as the darling bank of startups and tech companies in Silicon Valley.
Source: SVB Q4 2022 Financial Highlights
SVB's sudden fallout has left the industry in shock despite its privilege in the category. Within 48 hours, the 40-year-old bank was shut down, causing a significant impact that quickly went viral over the weekend, terrifying Silicon Valley.
Mar 8th 2023:
Silicon Valley Bank concerned investors when it said it needed to shore up its balance sheet and raise $2 billion in capital.
Moody’s, a credit ratings firm, downgraded the bank’s bond rating
Mar 9th 2023
Panic spread on social media among investors. Founders crushed to move their funds to other banks.
$42 billion was withdrawn by the close of this business day.
Mar 10th 2023
SVB failed on a bank run.
At noon, it was shut down by the regulators and handed over to the Federal Deposit Insurance Corporation (FDIC)
Learn more here.
According to Garry Tan, President & CEO of Y Combinator, the fallout could threaten years of US innovations if regulators do not take action to support depositors. Around 40,000 SVB depositors are small businesses, of which 30% are expected to fail to make payroll in the next 30 days, putting an estimated 120,000 jobs at risk.
What were the reasons for SVB’s sudden fallout?
The story began two years ago in 2021, the era of cheap money and the boom of new tech company IPOs. The U.S. VC investment growth rate in 2021 doubled vs. 2020 due to FED’s economic stimulus package and all-time-low interest rate.
With excessive money inflow, SVB allocated 55% of its assets (~ $117B) to Fixed Income Securities.
Source: SVB Q4 2022 Financial Highlights
Looking at its allocation in fixed income portfolio, it should be fine as U.S. Treasuries are considered as risk-free investment. However, one important factor which was not mentioned in this report is duration risk. In order to gain a better yield, SVB invested in long-term government bonds and mortgage-backed securities. In a stable low interest rate condition, there is nothing to worry. But FED’s monetary policy in 2022 was the game changer leading SVB to fall from the top to its end. Interest rate has been increased in the fastest manner in the U.S. modern history, from near zero to almost 5% over one year.
Source: SVB Q4 2022 Financial Highlights
The problem came from that 94.4% of SVB’s deposits were in HTM (Held-To-Maturity) securities and loans. SVB used its short-term liabilities to sponsor for its long-term investments. It was the first vulnerability.
When FED raised interest rate in 2022 and the macro economic picture became gray with many uncertainties, the deposit flow from VC decreased 31% vs. 2021 while the startup cash burn increased significantly. It means that its customers' withdrawal amount exceeded its deposits, which was the second vulnerability.
Source: SVB Q4 2022 Financial Highlights
Another consequence of FED's monetary policy is that when the interest rates increase, the bond prices go down. With a huge amount of money locked in long-term bonds, it created huge technical losses that would be materialized if they were forced to sell their assets before the maturity date, which was the third vulnerability.
The confluence of these three vulnerabilities peaked on March 8th, 2023, when SVB announced its intention to raise $2 billion of capital to add to its balance sheet after selling its AFS (Available For Sale) securities at a loss. The panic immediately spread in Silicon Valley, leading to a bank run when trust was lost.
The question is why SVB's management team could put a huge amount of deposits locked in long-term investments without sufficient hedging strategies. The answer could be their arrogance or over-confidence in the stability of FED's monetary policy, or greed, which resulted in short-sighted decisions. Whatever reasons it could be, the reality was that SVB had made irreparable mistakes, which immediately put thousands of startups, small businesses, and their employees at risk.
What can be learned from it?
Lindy Effect, which means the longer something has survived, the longer it is likely to exist into the future, is not always correct. SVB has history of 40 years, Signature Bank has 24 years, while Credit Suisse has 167 years in operation. These numbers tell us one thing: Everything has exceptions and no company is too big to fail. The financial world is unpredictable, and we must be prepared for unexpected events.
There are two sides to every coin. Opportunity can be a threat and vice versa. The fact that SVB received an excessive amount of money in 2021 was a positive sign for the company, but it also contributed to its demise two years later. When conditions are favorable, don't be overconfident, and when conditions are unfavorable, don't be depressed. We must always be conscious of external factors and adjust our strategies accordingly.
People overrated the capability of fund managers in risk management. We assume that they are knowledgeable experts with a broad range of sophisticated investing techniques.The reality has proven the opposite truth. In SVB case, the risk management was put behind the priority for getting higher profit. You can do right all the time, but just one mistake could result in drowning.
There is no safe place for your assets when they are managed by others. This issue affects all traditional banks, not just SVB. When you give someone else your money, there is always a chance that it wouldn't come back to you. Not your key, not your money!
When it comes to a panic, the herd psychology becomes dominant. It is the truth behind any bank run. Don’t expect that in this time people will react differently.
Social media plays a key role in navigating the narratives. It has a part in SVB’s 48-hour collapse when billionaires like Peter Thiel or Bill Ackman gave warnings on Twitter. Messages from founders went so viral that $42 billion was withdrawn in just one day. Nothing could be kept secret from the public in this era of rapid information flow, and social media is a powerful tool. The short-queeze of Gamestop and AMC popularized on Reddit is another example.
For businesses whose entire funds were put in SVB, this event might be a "black swan" event. When suddenly these businesses run out of money to pay employees' salaries and maintain operations, it can also be a "black swan" event for the partners or employees of these businesses. A black swan event can happen any time. How have your companies and you as employees prepared for such adversity?
What should we as indiviuals do?
Diversify assets: Rather than keeping all of your money in a single bank or investment account, spread your wealth across various financial institutions and investment vehicles. This time-tested advice has proven its worth, as diversifying your assets helps you manage risks. Life is unpredictable, but diversification can provide a buffer against unexpected events. Moreover, some assets have no correlation with others, making them an effective hedge for your portfolio. For instance, during periods of economic uncertainty or market turbulence, many investors opt to shift their money away from stocks and towards "safe haven" assets such as gold and bonds. These assets are typically perceived as less volatile and more secure than stocks.
Build an emergency fund: By setting aside cash or other easily accessible liquid assets, you can be prepared to handle unforeseen expenses that may arise. It's recommended to save enough to cover at least 3-6 months of expenses in case of an unexpected job loss or other financial setback. Having an emergency fund provides a safety net and peace of mind, knowing that you have a cushion to fall back on if needed.
Learn investing: It is the skill that people regardless of their occupations, should learn. You can develop the knowledge and skills to make your own investment decisions, manage risks based on your risk tolerance and financial goals, especially avoid relying solely on professionals to manage your money. Not all financial professionals perform risk management properly, as clearly shown in the SVB fallout.
Do self-custody: All banks are doing the same job which is managing your assets. Now we have blockchain available, it's the right time to learn how to handle your own asset custody because banks can fail at any time. When you store your assets in the Metamask wallet, for instance, only you can access your fund. While decentralized and non-custodial wallets still have a far way to reach mass adoption, it is most likely the path to come.
Cheers,
Do Thi Dieu Thuong