Two weeks ago, few people outside the tech industry had heard of Silicon Valley Bank (SVB), the mid-sized California lender whose rapid implosion would eventually shake the foundations of the entire global financial system.
But on the morning of Friday, March 10, after customers withdrew $42 billion in the span of a single day, state and federal regulators swooped in to try to save what was left of SVB.
In the dizzying 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 U.S. history, after Washington Mutual in 2008.
As analysts and regulators began to sift through the “rubble,” several red flags emerged. Surprisingly, SVB’s vulnerabilities were not very complicated. This was not in 2008, when obscure products at the center of a labyrinthine Wall Street derivatives market turned out to be useless and ended up devastating the U.S. housing market.
In the SVB autopsy, there are clear signs of basic corporate mismanagement, and when mixed with old-fashioned client panic, it turned out to be a crucial failure.
So why did no one see SVB’s collapse coming? That’s likely to be one of the key questions for lawmakers on Capitol Hill next week, in back-to-back House and Senate hearings investigating the bank’s collapse.
The unsatisfactory answer, for now, is that no one knows, or at least no one who is willing to say it out loud. But what is clear is that SVB’s failures are not the fault of any one person, system or asset, but a cacophony of missed warning bells.
Warning bells abound
SVB, founded in 1983, was both a financial institution and a status symbol among Bay Area businesses and wealthy individuals. It catered to a world of venture capitalists known as much for their staggering wealth as for their abundant appetite for risk. To bank with SVB was to be part of an elite club. To embrace an ethos unique to Silicon Valley that champions boldness, growth and disruption.
Like the startup clientele it courted, 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 US$209 billion in assets. That should have set off alarm bells on its own.
Warning sign #1: rapid growth
When banks grow rapidly, there are red flags everywhere, says Dennis M. Kelleher, CEO of Better Markets. That’s because a bank’s management capacity and compliance systems rarely grow at the pace of the rest of the business.
In fact, back in 2019, four years before SVB’s collapse, the Federal Reserve warned the bank about its insufficient risk management systems, according to a report in The Wall Street Journal and The New York Times. It is unclear whether the Fed, SVB’s top federal regulator, took action on that warning. The central bank is reviewing its oversight of SVB.
“My only interest is that we identify what went wrong here,” Fed Chairman Jerome Powell said Wednesday at a news conference. “We will find it and then make an assessment of what are the right policies to implement so that it doesn’t happen again.”
Warning sign #2: speculative money
Virtually all – 97%, according to Wedbush Securities data – of SVB’s deposits were uninsured.
Typically, U.S. 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.
It is tremendous because if you are an individual or a company with a lot of uninsured money in an institution, you will rush to withdraw that money if you suspect the bank may be in trouble.
SVB’s over-reliance on these deposits made it extremely unstable. When some members of its tight-knit, socially engaged customer community began to worry about the bank’s viability, the panic went viral.
Red flag #3: the customer base
Silicon Valley Bank was known for working with young tech startups that other banks may have shied away from. When those startups flourished, SVB grew along with them. The bank also managed the personal wealth of the founders of those startups, who often had little cash as their fortunes were tied to the shares of their companies.
“It was geographically concentrated. It was concentrated in 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 the bank’s 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 for alarm.
“The bank would have looked healthy, if you look at its capital position, its liquidity ratios … it would have been fine,” said John Sedunov, professor of finance at Villanova University. “Those traditional big picture things, the front-page items … They should have been fine.”
Time bombs lurked one layer deeper, in building the bank’s portfolio and building liabilities, Sedunov noted.
Silicon Valley Bank held an unusually large proportion (55%) of its customer deposits in long-term Treasury bonds. Those are usually super-safe assets, and SVB was not alone in loading up on bonds in the era of near-zero interest rates.
But the market value of those bonds declines when interest rates rise.
Typically, a bank hedges its interest rate risk using financial instruments called swaps, effectively swapping a fixed interest rate for a floating rate over a period of time to minimize its exposure to rising rates.
SVB appears to have had zero hedges in 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 commented. “It’s textbook stuff.”
Red flag #5: not having a chief risk officer.
Over the past year, the Federal Reserve raised interest rates at a pace 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 a chief audit officer,” said Art Wilmarth, a George Washington University law professor and financial regulatory expert. “Every bank of that size is required to have a risk management committee. And the chief risk officer is the No. 1 person reporting to that committee.”
For a chief risk officer to be absent for eight months, as SVB was, is “surprising,” 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 merit a course correction.
But even without a chief risk officer, there is little excuse for SVB to have no apparent hedges in its bond portfolio.
Several experts who spoke to CNN said it’s likely that people inside 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 asserted. “Because, again, if you comply with a lot of the general things, maybe they thought, well, they can survive something? What’s the likelihood that you have US$40 billion in withdrawals at the same time? ”