Hi guys, this week’s newsletter is coming quite early because I just couldn’t sit on the news about the Silicon Valley Bank. There has been a lot of PR and Fanfare about the fall of Silicon Valley Bank, so I have broken it down for those of us who can’t be bothered to sift through 101 articles.
Silicon Valley Bank (SVB) was a commercial bank located in California; at the time of its failure (10th of March 2023), it was the largest bank by deposits in Silicon Valley, USA.
The bank specialised in lending money to early-stage technology companies and was the banking partner of nearly half of US venture-backed technology and healthcare companies listed on the stock market in 2022.
SVB collapsed in the US (within 48 hours) after failing to raise $2.25bn (£1.9bn) to plug steep losses from the sale of assets (mainly US government bonds); which caused customers and investors to fear. As a result, the SVB was shut down by regulators who seized their assets.
This has been the largest failure of a US bank since the 2008 financial crisis.
What happened?
The SVB at its core, accepted deposits from the public and loaned the deposits to customers. Companies and Individuals could also deposit or ‘save’ money into the bank. It was a bank like any other.
There is a fractional reserve system in banking which states that a bank must keep some deposits in reserves within the Apex bank (e.g. Bank of England) – this is known as cash reserves. A bank can do as it pleases (in line with economic policies) with the balance. They can trade, buy or invest in other companies etc.
This usually works fine, because nobody withdraws or spends all their money at the same time so banks are generally ‘safe’.
But…the United States currently operates on a no-reserve banking system- with a cash reserve of 0%
Tech start-ups and businesses have large sums of money stashed in banks. Due to recession expectations – organisations have been saving a lot of cash to play it safe.
At the height of Covid, interest rates were low and Treasury bills (a safe, no- risk investment) paid 0.25 % interest. This meant that if a bank had $100 billion lying around, they would’ve made $25 million with their feet hanging up just by investing in treasury bills….
The SVB made a decision to invest about $80 billion in Mortgage Backed Securities(MBS)- Bonds which paid interest of 1.5% which was higher than the interest of treasury bills (0.25% at the time)
This backfired because the interest rates didn’t stay low forever. Bonds and interest rate prices have an inverse relationship- the higher the interest rate, the lower the bond price . When interest rates increase, Mortgage-Backed Securities aren’t the best investment because the yields (return on investments) reduce.
Treasury bills reflect the current interest rate of 4.65%.
Nobody needed the MBS bonds anymore- they were no longer outperforming treasury bills. The SVB was overexposed to Mortgage Backed Securities.
Typically, a Bond can be held to maturity - e.g 10 years or sold early – losses will be incurred in this case.
SVB sold their bonds before the maturity, cutting their losses before things potentially got worse and hoping to cushion their losses by raising capital from investors, but they made a big mistake- they announced their capital raise plans at the same time at announcing a $1.8 billion loss which made people panic.
There was a market frenzy and the bank couldn’t meet its withdrawal requests.
This led to a phenomenon called a ‘Bank Run’
‘A bank run occurs when large groups of depositors withdraw their money from banks simultaneously based on fears that the institution will become insolvent.’
What does this mean?
Initially, the US government allowed the SVB to fail without protecting depositors, but other countries have different monetary and fiscal policies; other institutions can be bailed out by the governments in which they exist.
In Financial institutions, a customer’s deposits are protected up to a certain amount. In the UK, £85000 is covered by the UK’s insurance scheme. The sad part is that customers like tech firms have larger amounts of money saved.
The huge cash deposits in the SVB meant that tech firms might have not been able to reach payroll at the end of March, especially if they had no other contingencies in place.
Some firms have 100 percent exposure to the SVB and served millions of people in the alongside businesses that are critical to the economy.
The cost of government inaction meant that large firms could seemingly fail only in the short-term, but technology growth ambitions for the entire economy will fail in the long-term.
Just imagine a large firm like Monzo or Revolut failing because of exposure to the SVB. What happens to small businesses and startups? What is the trickledown effect on the UK economy, employment rates and GDP?
What’s Next?
The US government claims that money in a failed bank is safe: the Federal Reserve said it would assist through a new Bank Term Funding Program, making it easier for banks to borrow from it in a crisis. The statements assure citizens that taxpayer’s money will not be used for the move.
The type of people who banked with the SVB - the ‘tech elite’/ ‘tech bros’ are usually liberals who believe that the government is too slow and too big, but the same republican (conservative) government bailed them out.
Some people believe that tech bros have been give preferential treatment : ‘capitalism’ for when things go well and socialism for when they don’t.
As of today : March 143th 2023, HSBC has acquired the UK branch of SVB for just £1– the deal involved no taxpayer’s money . The political angle for the move, is that Rishi Sunak is releasing its UK budget on Wednesday and he has promised to make the UK a ‘tech superpower’ ; it would’ve been bad PR if UK tech companies couldn’t make payroll.
My thoughts
There are many societal problems in need of resolution; people in lower tax brackets are suffering from a lack of political reform, social capital, and funding, so in times like this, there needs to be reassurance that the average man isn’t paying for the bailout of tech giants.
The SVB gave the tech industry many years of bliss- they built a community and enabled founders to help each other. It all came crashing down due to selfish motives, greed, fear, and impatience.
If only people could just wait a little bit longer before making big moves.
I also don’t buy the ‘no taxpayers money’ trope. There are indirect costs to Quantitative Easing and we will all be taxed either way- the money doesn’t come from thin air.
Overall, I believe that economic frenzy is always the beginning of the end for many firms, but also gives room for the growth of new institutions. I am looking forward to what’s to come.
I end with this biblical quote
– 2 Peter 2:3 ‘ And in their greed they will exploit you with false words’
More to come, Hope you enjoyed this article , Daisy Ossai