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The financial institution best known for its ties to tech startups and venture capital firms, Silicon Valley Bank, experienced one of the oldest problems in banking – a bank run – which led to its failure on Friday.
The collapse was the biggest failure of a financial institution in the United States since Washington Mutual collapsed at the height of the financial crisis more than a decade ago. And there is an immediate effect.
Some startups that have relationships with banks scrambled to pay workers, and fear they will have to pause projects or lay off employees until they can access funds.
How did that happen? Here’s what to know about why the bank failed, who was most affected, and what to know about how it might, and might not, affect the broader U.S. banking system
Why did it fail?
Silicon Valley Bank has been hit hard by the decline in tech stocks over the past year as well as the US Federal Reserve’s aggressive plans to raise interest rates to fight inflation.
The bank has bought billions of dollars worth of bonds over the past few years, using customer deposits as the bank normally operates. These investments are usually safe, but the value of the investment declines because it pays a lower interest rate than comparable bonds would pay if issued in today’s higher interest rate environment.
Usually, this is not a problem, because banks have been around for a long time – unless they have to sell in an emergency.
But Silicon Valley’s customers are mostly startups and other tech companies that have started to need more money over the past year. Venture capital funding has dried up, companies can’t get additional funding for unprofitable businesses, and so they have to tap into existing funds – often deposited in Silicon Valley Bank, which is at the heart of the tech startup world.
So Silicon Valley customers started withdrawing their deposits. At first it wasn’t a big deal, but the withdrawals required banks to start selling their own assets to meet customer withdrawal demands. Because Silicon Valley’s customers are mostly businesses and rich people, they are more afraid of bank failure due to deposits of more than US$250,000, which is the limit imposed by the US government for deposit insurance.
Those who need to sell bonds are usually safe at a loss, and those losses add up until Silicon Valley Bank goes bankrupt. The bank tried to raise additional capital through outside investors, but was unable to find them.
Banks focused on technology are brought down by the oldest problem in banking – which runs in the bank.
Bank regulators should seize Silicon Valley Bank’s assets to protect the bank’s remaining assets and deposits.
What happens next?
There are two big problems left at Silicon Valley Bank. Both can lead to other problems if not resolved quickly.
The most immediate problem is the large deposit of Silicon Valley Bank. The US government insures deposits up to $250,000, but anything above that level is considered uninsured. The Federal Deposit Insurance Corporation said insured deposits would be available Monday morning. But most of Silicon Valley Bank’s deposits are uninsured, a unique characteristic of the bank because its customers are mostly startups and wealthy tech workers.
Currently, all that money is inaccessible and should be released through an orderly process. But many businesses cannot afford to wait weeks to access funds to meet salaries and office expenses.
Two, no one bought Silicon Valley Bank. Bank regulators usually look for stronger banks to take over the assets of failed banks, but in this case, other banks have not stepped forward. A bank that buys Silicon Valley Bank may be able to solve some of the money-related problems that startups don’t have access to today.
What are the signs of a repeat of 2008?
Currently, no, and experts do not expect the problem to spread to the wider banking sector.
Silicon Valley Bank is big but has a unique existence by serving almost the entire world of technology and VC-backed companies. It does a lot of work with certain parts of the economy that were hit hard last year.
Other banks are more diversified across multiple industries, customer bases and geographies. The latest round of “stress tests” by the Federal Reserve of the largest banks and financial institutions show that they will all survive a deep recession and a significant drop in unemployment.
But there could be an economic ripple effect in the Bay Area and in the tech startup world if the remaining money can’t be released quickly enough.
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