The fall of Silicon Valley Bank (SVB) sent shockwaves across the financial world. As the fastest bank collapse in history, SVB was seized before most people had enough time to google “What is SVB?”.

To put the speed of the bank failure into context, when Washington Mutual failed in 2008, its bank run was a result of depositors withdrawing $16.7 billion within eight working days. However, the collapse of SVB occurred at breakneck speed with depositors requesting $42 billion in withdrawals within one working day.

But for Canadians, it’s worth re-iterating just how different the banking system is here versus our US brethren. For starters, if you go back to the Great Depression, more than 9,000 US banks failed (versus none in Canada). Not coincidentally, that’s why deposit insurance was invented. But even so, 563 US banks have failed between 2001 and 2023, with most of those occurring during the Great Financial Crisis (GFC) of 2008/9. The tally for Canada during that same period? Zero.

Let’s go over the basics of SVB at eye-level. Why were they different than most banks? Why did they fail? And what are the questions we should be asking going forward?

What Was Silicon Valley Bank?

SVB was a unique bank that set itself apart by focusing on the technology industry and the startup ecosystem. Unlike traditional banks, SVB catered to tech companies, venture capital firms, and entrepreneurs. This specialization allowed SVB to develop deep relationships within the tech community and establish itself as a key player in financing innovation. This specialization and, more importantly, super-concentration in this sector is key to the story.

Why Did It Fail?

Here is a really quick and simplistic primer on a core banking function that is relevant to understanding why SVB failed. If a bank offers savings accounts that pay 2% in interest but charge 4% to borrowers on their mortgages, the difference in what they pay out in interest and what they earn in interest is one of the ways a bank makes money.

But SVB’s customers were not like the average bank customer. When you hear things like “Tech Company X raises $50 million in Series B funding”, Tech Company X might have put that $50 million in cash into a bank account with SVB, but Tech Company X might not need loans. This means SVB needs to find another way to earn interest on all their startup companies’ cash balances. So, instead of earning interest on mortgages and other loans, they could invest that money. In SVB’s case, they bought longer-term bonds (among other investments) that offered a slightly higher interest rate.

This strategy increased the risk of the bank’s operations. And then a perfect storm formed.

Strike One

As we all know, interest rates have been rising quickly. On top of that, startups and tech have been under pressure with big declines in stock prices and numerous rounds of layoffs. That environment is not conducive to new funding, so new cash deposits for new rounds of funding dried up. So the truckloads of cash coming into SVB stopped. Strike one.

Strike Two

And when interest rates rise, bond prices fall, which meant that the investments that SVB was relying on to fund decent interest rates to the depositors were cratering in value. Strike two.

Strike Three

As people began to take notice, curiosity and concern set in. Confidence is a vital component in a thriving banking system — i.e., knowing that when you deposit your money, it’ll be there when you need it. But when depositors suspect a bank is on shaky ground, the race is on to withdraw funds before others do. After all, if you’re last in line, you might find your cash has vanished into thin air. Consequently, there’s a powerful incentive to act swiftly.

Now, deposit insurance guarantees the safety of member bank deposits up to a certain amount in case a bank fails or goes bankrupt. In the United States, the Federal Deposit Insurance Corporation (FDIC) provides this service, with the standard insurance amount up to $250,000 per depositor, per bank. In Canada, the Canada Deposit Insurance Corporation (CDIC) offers deposit insurance, and the coverage limit is up to $100,000 per depositor, per insured category at each member institution. In fact, you as an individual could have multiples of $100,000 of coverage with the same financial institution in Canada.

For most people, breaching their coverage limit isn’t a major concern, which boosts their confidence in knowing that, should disaster strike, insurance will have their back. But SVB’s situation was a different ballgame: their over-concentration of tech and startup clients meant many had bank balances that soared past deposit insurance limits — think millions upon millions over the line. And with that, we find strike three.

The Impact of Social Media Vs. Traditional Media

Put all these unique factors together and suddenly you could connect the dots of how it would be possible for a customer to lose their deposits at SVB. The New York Times reported that a major debt rating agency went to SVB and told them they were in danger of getting downgraded. In response, SVB sold some of their bonds to raise cash (at a big loss). They also sold some stock and cut their profit outlook. Not exactly confidence inspiring.  

Once blood was in the water, the interconnectedness of the tech and venture capital community allowed for the lightning quick collapse of SVB. Patrick McHenry, Chair of the House Financial Services Financial Committee, declared it the first “Twitter-fueled bank run”.

Amplification of fear played a role in SVB’s rapid collapse. Prominent investors, entrepreneurs, and other internet personalities took to social media to express their concerns and fears about the situation. But after the regulatory filing SVB made on March 8th about selling stock and the losses it took selling bonds, the fall in SVB’s share price ignited Slack channels and WhatsApp groups within the community.

During the 2008 financial crisis, information was disseminated through traditional media channels, which offered a slower and more controlled flow of information. In contrast, 2023’s messaging and social networks allow for instantaneous sharing of opinions, speculations, and memes, making it difficult to separate facts from rumors.

Financial Regulation and Corporate Risk Management

The role of electronic messaging and social media in SVB’s collapse highlights the need for financial regulators to continue considering the influence and power of these platforms in shaping market dynamics. (Remember WallStreetBets and the rise of memestocks?)

Information on social media spreads rapidly, which can lead to panic and instability in financial markets. The SVB debacle serves as a cautionary tale for the financial world, reminding us that in this interconnected era, the line between confidence and panic can be as thin as a tweet.

But while a lot of media attention has been focused on the killing stroke for SVB, the bigger story is how did a US bank get into this position in the first place?

Management made a decision that increased risk to its operations. Many fingers are pointing to legislation passed in 2018 that effectively loosened US regulations brought in as a result of the Great Financial Crisis. Specifically, the threshold for heightened scrutiny for banking operations was increased from banks with more than $50 billion in assets to banks with over $250 billion in assets. Had that regulatory roll-back not occurred, it’s possible SVB would not have put itself in a position which led to its failure.

At the very least, this should give regulators and lawmakers pause about pushes for deregulation. At least in the US, where the “it’s been ___ days since a bank collapsed” board has recently been reset to zero. We don’t even have to bother with one of those in Canada.

Rising Interest Rates Were Never Going to Be Anything But Painful

Finally, rapidly rising interest rates to combat inflation was expected to have consequences. The delicate balance between controlling inflation and maintaining economic stability is challenging to achieve, and the fallout from rate hikes was arguably inevitable. The recent events involving SVB and other financial institutions serve as a reminder that central banks face an uphill battle.

As the dust settles on SVB’s collapse, investors can’t help but question whether other institutions have stretched their risk boundaries to thrive in what now feels like the bygone era of persistently low interest rates. The situation remains fluid, and whispers of contagion within the markets are likely to make headlines for at least the foreseeable future.

Originally trained as a neuroscientist, Preet Banerjee now excels within the world of finance. Best known as a financial panelist on CBC’s The National, Preet has a unique ability to take the complexity out of money matters and speaks on behavioural finance, economics, and personal finance.

Contact us to learn more about Preet and what he can bring to your next event.