New York () — Two weeks ago, few people outside the technology industry had heard of Silicon Valley Bank (SVB), California’s midsize lender whose rapid implosion would ultimately shake the foundations of the entire global financial system.
But on the morning of Friday March 10, after clients withdrew $42 billion in the span of a single day, state and federal regulators swooped in to try to salvage what was left of SVB.
In the heady hours that followed, Silicon Valley Bank became a global household name, though hardly in a way its founders would have expected: It was officially the second largest banking collapse in US history, after Washington Mutual in 2008. .
As analysts and regulators began to examine the “debris,” several red flags emerged. Surprisingly, the SVB vulnerabilities weren’t very complicated. This was not in 2008, when shadowy products at the center of a labyrinthine Wall Street derivatives market turned out to be worthless and ended up devastating the US housing market.
A bank run wiped out Silicon Valley Bank on March 10, when depositors withdrew $42 billion in a single day. (Credit: Jeff Chiu/AP)
In the SVB’s autopsy, there are clear signs of basic corporate mismanagement, and when mixed with old-fashioned customer panic, it turned out to be a crucial flaw.
So why didn’t anyone see SVB’s collapse coming? That is likely to be one of the key questions from lawmakers on Capitol Hill next week, in back-to-back House and Senate hearings investigating the bank’s downfall.
The unsatisfactory answer, for now, is that no one knows, or at least no one willing to say it out loud. But what is clear is that the SVB’s failures are not the fault of any one person, system, or asset, but rather a cacophony of warning bells that went unnoticed.
Warning signs abound
SVB, founded in 1983, was both a financial institution and a status symbol among businesses and wealthy individuals in the Bay Area. He catered to a world of venture capitalists known for both their staggering wealth and their abundant appetite for risk. Banking with the SVB was like being part of an elite club. Embrace a uniquely Silicon Valley ethos that champions boldness, growth and disruption.
Like the start-up clientele it courted, the SVB grew at a breakneck pace with assets nearly quadrupling between 2018 and 2021. It was the country’s 16th-largest bank at the end of 2022, with $209 billion in assets. That should have set off alarm bells on its own.
Red flag #1: vertiginous growth
When banks grow rapidly, there are red flags everywhere, says Dennis M. Kelleher, CEO of Better Markets. That’s because the bank’s management capacity and compliance systems rarely keep pace with the rest of the business.
In fact, already in 2019, four years before the collapse of the SVB, the Federal Reserve warned the bank about its insufficient risk management systems, according to a report from The Wall Street Journal and The New York Times. It is not clear if the Fed, the main federal regulator of SVB, acted on that warning. The central bank reviews its supervision of SVB.
“My only interest is that we identify what went wrong here,” Fed Chairman Jerome Powell said at a news conference on Wednesday. “We’ll find it and then we’ll do an assessment of what are the right policies to put in place so it doesn’t happen again.”
Red flag #2: hot money
Virtually all — 97%, according to Wedbush Securities data — of SVB’s deposits were uninsured.
Typically, US banks fund 30% of their balance sheets with uninsured deposits, said Kairong Xiao, a professor at Columbia Business School. But SVB’s was “an incredible amount,” he says.
Silicon Valley Bank kept 55% of its clients’ deposits in long-term bonds whose value eroded as interest rates rose. (Credit: Kori Suzuki/Reuters)
It’s tremendous because if you are a person or a company with a lot of uninsured money in an institution, you will be quick to withdraw that money if you suspect the bank may be in trouble.
SVB’s excessive reliance on these deposits made it extremely unstable. When some members of its tight-knit and socially engaged customer community began to worry about the bank’s viability, the panic went viral.
Red flag #3: the clientele
Silicon Valley Bank was known for working with young tech startups that other banks may have avoided. As these new companies flourished, the SVB grew along with them. The bank also managed the personal wealth of the founders of those startups, who were often short on cash as their fortunes were tied to the shares of their companies.
“I was geographically focused. It was focused on one segment of the industry, and that segment of the industry was extremely sensitive to interest rates,” Kelleher said. “Those three red flags alone should have caused bank officers and directors to take corrective action.”
Red Flag #4: Risk Management 101
A casual observer of Silicon Valley Bank’s financial position even a month ago would have had little reason to be alarmed.
“The bank would have looked healthy, if you look at their capital position, their liquidity ratios… it would have been fine,” said John Sedunov, a finance professor at Villanova University. “Those traditional big picture things, the front page items… They should have been fine.”
Time bombs were lurking a deeper layer, in building the bank’s portfolio and building liabilities, Sedunov said.
Silicon Valley Bank held an unusually large proportion (55%) of its clients’ deposits in long-term Treasury bonds. Those are usually super-safe assets, and SVB wasn’t the only one loading up on bonds in the era of near-zero interest rates.
But the market value of those bonds falls when interest rates rise.
Typically, a bank hedges its interest rate risk using financial instruments called swaps, effectively exchanging a fixed interest rate for a floating rate over a period of time to minimize its exposure to rising rates.
The SVB appears to have had zero hedges on its bond portfolio.
“Frankly, managing your exposure to interest rate risk is one of the first things I teach in an undergraduate banking class,” Sedunov said. “It’s textbook stuff.”
Red flag #5: Not having a chief risk officer
Over the past year, the Federal Reserve has raised interest rates at a rate unprecedented in the modern era. And for most of that year, Silicon Valley Bank operated with a huge vacancy on its corporate leadership team: a chief risk officer.
“Not having a chief risk officer is like not having a chief operating officer or chief audit officer,” said Art Wilmarth, a George Washington University law professor and an expert on financial regulation. “Every bank of that size is required to have a risk management committee. And the chief risk officer is the number 1 person reporting to that committee.”
For a chief risk officer to be absent for eight months, as the SVB was, is “astonishing,” Wilmarth said.
In theory, a chief risk officer would have been able to spot the outsized risk posed by the declining value of the bank’s long-term bonds, which, combined with its outsized deposit risk, would warrant a course correction.
But even without a chief risk officer, there is little excuse for the SVB not to have apparent hedges in its bond portfolio.
Several experts who spoke to said it’s likely that people inside the SVB knew about the risks but let them slide. After all, the bank was well capitalized. It was profitable. And hadn’t regulations since the 2008 crisis made all banks safer?
“I’m sure somebody saw, and I’m sure somebody let it go,” Sedunov said. “Because, again, if you meet a lot of the general stuff, maybe they thought, well, they can survive something… What’s the probability that I have $40 billion in withdrawals at the same time? ”
