The March 10 collapse of Silicon Valley Bank marked the United States’ second-largest bank failure in absolute dollar amount, and the seventh largest relative to the size of the financial system. Founded in 1983, Silicon Valley Bank was the 16th-largest bank in the U.S. and a leading funding source for tech-centered and startup firms before its failure. This sudden downturn has prompted concerns about the health of the country’s financial system, as well as intense debate around what the bank’s insolvency will mean for entrepreneurship and the technology sector. Yunzhi Hu, UNC Kenan-Flagler Business School assistant professor of finance, took a moment to answer some questions about why the bank failed as well as possible ramifications.
What happened to Silicon Valley Bank?
Yunzhi Hu: Silicon Valley Bank (SVB) experienced a classic bank run scenario, whereby customers rush to withdraw their deposits. The run was triggered by a combination of at least two factors. First, SVB has a large fraction of its portfolio invested in bonds – in particular, long-term Treasury bonds and mortgage-backed securities. After multiple interest rate increases by the Federal Reserve, the market value of these bonds has fallen substantially. Second, most of SVB’s depositors are technology firms and startups, and their deposits are typically far more than $250,000, the amount covered by Federal Deposit Insurance Corp. (FDIC) insurance. So, when news that SVB sold a portfolio of bonds for about $21 billion at a $1.8 billion loss came out last week, these uninsured customers panicked and rushed to withdraw their deposits. SVB’s stock price dropped more than 60% on Thursday, March 9, and trading was eventually halted before the market opened March 10. SVB attempted to raise capital but failed.
How much of this issue is specific to SVB and similar entities, or is this a leading indicator of broader financial distress?
Hu: On Sunday, March 12, Signature Bank also failed. Similar to SVB, about 90% of Signature’s deposits are uninsured, but unlike SVB, much of Signature’s business is tied to the crypto industry. On Monday, small and regional banks’ stock prices plunged following news on SVB, whereas big banks such as JPMorgan were not affected as much. This is at least partly because a larger fraction of deposits at small and regional banks is uninsured. It is unclear how much of the problem is specific to SVB and how much is more general for the entire banking sector. Part of the issue with SVB is insufficient hedging against interest rate risks, which could be better managed by other banks. Large banks tend to have a smaller fraction of their portfolios invested in bonds, and bonds differ from loans – the former tend to have fixed rates, while the latter have floating rates and are not as subject to interest rate risks.
Overall, if one looks at indicators such as capital levels and liquidity, the banking sector in the U.S. seems to be in good shape. It does not seem likely that this event can trigger a systemic event such as the next large-scale crisis. That said, it is always hard or even impossible to predict financial crisis.
How has the government acted to stop a broader financial crisis? Do you think it will be effective?
Hu: With at least two related goals, the government stepped in as soon as possible to calm the panic and stop the contagion. The Treasury, the Federal Reserve and the FDIC issued a joint statement on March 12 intended to restore confidence in the financial system. The FDIC completed its resolution of Silicon Valley Bank; all depositors, including those with uninsured deposits, could access all their money starting March 13. Similar measures were taken for Signature Bank. Finally, the Fed announced a new lending facility to provide liquidity to eligible institutions in case of excessive withdrawals. Based on historical episodes, I think these actions are timely and should be effective in addressing panics if the problem is just about liquidity. So far, the problem does look more like a liquidity one, and issues on solvencies have not been clearly revealed.
The government decided to insure all deposits rather than insuring just the standard FDIC maximum of $250,000. What are the consequences of that decision?
Hu: In the short run, it can stop runs on other banks, especially the regional ones. By doing so, it is likely to remove panics for the entire banking sector. People always argue bank bailouts can lead to banks taking more risks in the longer term, which would be a form of moral hazard. However, there is a lack of direct, clear evidence that this relationship holds and is economically significant.
Given SVB’s relationship with the tech world, what are the consequences of its failure beyond the potential financial contagion?
Hu: SVB is the largest issuer of venture debt and serves almost half of venture-backed technology and healthcare firms. Its demise is going to introduce at least some short-term difficulties in raising financing to the tech world. As a result, it might wipe out a set of tech firms – in particular, firms that are smaller and less productive. The issue is less likely to persist in the longer run; some other banks and financing companies can step in and replace SVB, although they may not be as aggressive in risk taking.