Why did the Silicon Valley Bank fail?

On Friday 10 March US regulators shut down Silicon Valley Bank (SVB) and took control of its customer deposits in the largest failure of a US bank since 2008.

How did we get to this situation?

The background

The Silicon Valley Bank (SVB) is a business that specialises in funding businesses in the US technology sector particularly funding new businesses or start-ups. During the Covid pandemic, the firms SVB was funding generated huge sums of money because there was a boom in the sales of technology businesses that took place during the lockdown period.  This in turn led to a big increase in SVB's deposits. In March 2020 SVB had around $60 billion in total deposits but this reached $200 billion by March 2022.

SVB used the deposits it received to buy tens of billions of dollars of relatively safe assets, such as US government bonds and government-backed mortgage securities (bonds). This means that SVB’s holding of bonds increased from $27 billion in March 2020 to $128 billion by December 2021.

The problems start

The bonds SVB held are relatively low risk because the interest payments along with the repayment of the bonds will always be repaid to SVB. But these are long-term bonds so the repayment is not due for many years. SVB could sell the bonds on the money markets if it needed funds quickly.

Then came a rise in US interest rates from 0.5% in May 2022 to 4.75% in February 2023. This led to a fall in the value of the bonds SVB was holding because the interest rates on these bonds were significantly lower than the value of the bonds being issued in late 2022 and early 2023. At the end of 2022, the value of SVB’s bond holding was a $17 billion loss. However, this is not a problem unless SVB has to sell the bonds it holds.

By early 2023 SVB’s client businesses started withdrawing more money than they were putting in as the technology market slowed. As US interest rates increased SVB had to pay higher interest to attract new deposits.

The end game

On Wednesday 8 March 2023, SVB sold $21 billion of bonds to raise funds at a loss of $1.8 billion. SVB also tried to raise funds by issuing $2.25 billion in new share capital. SVB’s losses on its bonds and desire to raise funds quickly through a share issue caused the financial markets to worry about SVBs financial stability. Some of SVB's customers panicked. On Thursday 9 March, SVB's customers tried to withdraw $42 billion of deposits which is 25% bank’s total deposits. As a result of this, SVB ran out of cash.

The implication of SVB's failure

The failure of SVB is a major problem for its depositors who effectively lose their money. Some are protected by Federal Deposit Insurance but this is only the case up to a certain level of deposit. 

The failure of SVB has a knock-on effect on other banks because depositors in SVB might be in a position where they cannot pay individuals and depositors in other banks. This can trigger a loss of confidence in the whole banking sector in the US and in other countries as well.

It is important to understand the risk to the US financial system of the failure of SVB is the process of credit creation and how banks only keep a fraction of their deposits in a liquid form (can easily be turned into cash) which means banks at risk of bankruptcy if a large number of depositors try to withdraw their money.

Postscript

*The US government has informed SVB depositors that they will be able to access all of their money quickly following the bank's failure in a government-backed rescue plan.

Possible questions to discuss with a class

1. What is a bond?

2. Why did SVB hold bonds?

3. Why did the value of bonds SVB held fall?

4. Why did SVB's depositors lose confidence in SVB?

5. Why did SVB fail to pay its depositors when they tried to withdraw their money?