Silicon Valley Bank: How A Bank Fails

Silicon Valley Bank was shut down by regulators On Friday, March 10, in the biggest bank failure since 2008. At the end of 2022, the bank had assets of $ 209 billion. Bank failures can have many causes: fraud, bad credit or a mismatch of assets and liabilities. It appears that the asset-liability mismatch was behind the bank’s problems.

A bank takes deposits from customers, who can be individuals or businesses. It then invests most of those deposits in loans or securities, but keeps some cash in reserve for when depositors want the money back. Silicon Valley Bank was not your typical bank, which in itself is not a criticism. Most of their deposits came from large companies that were part of the tech sector. For example, a start-up receives $100 million from a venture capital fund. It parks that money at its local bank. Another company may have a treasurer who invests in commercial paper and other financial instruments to obtain the best possible short-term interest rate. But the chief financial officer of a start-up isn’t hired to get an extra five basis points from holding cash; The CFO has bigger issues to deal with and some staff members to help. So the CFO uses the bank.

The bank recognizes that this deposit base requires liquidity. Most banks put the bulk of their assets into loans, but most banks have many small depositors who will not suddenly need their money. So the Silicon Valley banks put most of their assets in US Treasury securities. There is no credit risk, so it seems safe.

Unfortunately, the best yields are usually found on longer-term bonds rather than shorter-term bills. The problem with long-term bonds is that when interest rates go up, the value of the old bond, which still pays the old interest rate, goes down.

SVP Financial Corp., the parent company of Silicon Valley Bank, reported at the end of the year Its bonds due 2022 were worth $117 billion but were bought for $127 billion. And that pricing calculation went south as interest rates rose. For example, the 10-year Treasury bond closed at 3.88% but peaked at 4.08% in early March. The increase in interest rates created an even bigger loss for the bank.

Still, the publicly available financials suggest to me that the bank was still solvent when it closed—solvent but in trouble. The trouble came from corporate depositors. FDIC insurance only covers deposits up to $250,000. A corporation with a $100 million deposit is just an unsecured creditor. And it is easier for a company to move its money from one bank to another or buy treasury bills or commercial paper. So when corporate depositors sensed that Silicon Valley Bank was in trouble, the smart and easy response was to withdraw.

As more money came out of the bank, it probably sold the securities. At some point, the bank will be left with illiquid assets: loans, leases, bank premises and equipment. Those assets have real value, but cannot be quickly converted into cash, meaning some depositors may not be able to get their money immediately.

The lesson of this bank failure applies not only to banks, but also to many companies. First understand the liabilities, especially how soon the creditors can demand repayment. Second, understand how quickly the asset can be turned into cash to meet the demands of creditors. Third, recognize that long-term assets typically lose market value when interest rates rise. Consequently, there is a danger in short term borrowing for long term lending. Bankers have learned that lesson firsthand. But as the great sailor Bernard Moetsier once said, the best lessons in life must be learned many times.