Up Next

Market-Based Solutions to Vital Economic Issues


Kenan Institute 2023 Grand Challenge: Workforce Disrupted
Market-Based Solutions to Vital Economic Issues
Apr 18, 2023

The Silicon Valley Bank Collapse: Takeaways and Lessons Learned

The sudden failure of Silicon Valley Bank in March caused serious concern throughout the financial world. The institution had been a lynchpin of the entrepreneurial ecosystem since its founding in 1983, serving roughly half of all venture-backed tech firms. In the weeks since its collapse, the banking world has been intensely debating the reasons behind the institution’s downfall, as well as any implications for the broader economy.

Much of this discussion has missed the mark, however, failing to provide clarity on the fundamental issues that were behind the bank’s collapse. Put simply, Silicon Valley Bank’s failure can be attributed to mismanagement of the bank’s balance sheet – and, specifically, insufficiently addressing the maturity mismatch between its assets and liabilities.

Like many banks, SVB’s liabilities were largely in the form of demand deposits; as such, these liabilities tend to be short term and far less sensitive to interest rate movement. By contrast, SVB’s assets took the form of more long-term bonds, such as U.S. Treasury securities and mortgage-backed securities. These assets tend to have a much longer maturity – the majority of SVB’s assets matured in 10 years or more – and as a result their prices are much more sensitive to interest rate changes.

The mismatch, then, should be obvious: SVB was taking in cash via short-term demand deposits and investing these funds in longer-term financial instruments. This isn’t an uncommon tension for a financial institution to experience, but the Federal Reserve’s 2022 interest rate hikes significantly altered the situation.

Since March 2022, the Fed has been raising interest rates in record-breaking fashion, approving the largest interest rate increases in almost 30 years. As the interest rate rose during the past year, the value of the long-term bonds in SVB’s portfolio began to fall. Because the value of deposit liabilities is fixed, this had a direct negative effect on their net asset base. The bank was able to cover this up by not recording the change in value of its bond assets on its balance sheet (using so-called held-to-maturity accounting, which allows for this).

However, this problem was an entirely foreseeable issue, and one that should have been effectively hedged – which is standard practice for every properly managed bank. SVB should have, for example, purchased fixed-for-floating interest rate swaps, which would change the maturity of those assets. Such a move would have protected it from exactly this kind of market risk due to rising interest rates, since the gains on these swap contracts are designed to offset the losses on the bond portfolio. Even though the extent of the Fed’s rate hikes in 2022 were somewhat unexpected, these hedges would have significantly mitigated the inherent risk in SVB’s portfolio.

At its core, then, SVB’s collapse should be viewed as a problem of risk management. In fact, this type of hedging is Banking 101 and the staple of the financial transformation function that banks have always had to manage. Given that 90% of its deposits exceeded the Federal Deposit Insurance Corp. insurance limit and were thus uninsured, this lack of sensitivity to interest rate fluctuations left it heavily exposed to a bank run, which is exactly what happened (though it was likely insolvent even without the bank run). To be absolutely clear, the bank run wasn’t the problem. It just revealed the underlying asset-liability risk management fiasco that was the fundamental failure.

Viewed through this lens, SVB’s collapse thus offers important takeaways for financial practitioners (especially at small to medium-size institutions) and regulators alike. For bankers, the collapse should underscore the need to properly hedge against interest rate risk. This especially holds true as the “era of easy money” comes to an end; for the bulk of the past decade, borrowing money has been historically cheap, and long-term interest rates have trended lower.

For policymakers, it becomes ever more crucial to ensure that regulatory policy is not only targeting the correct vulnerabilities in the banking system but also allows for immediate intercession when these vulnerabilities are identified. In the case of SVB, its balance sheet at the end of 2022 showed that the value of its long-term bonds had fallen far below the cost paid for them – and the bank had terminated or let expire rate hedges on more than $14 billion of securities. While things are always clearer in hindsight, signals of this kind should be clear red flags that an institution’s risk assessment is not accurate – and that greater regulatory inspection is needed.

You may also be interested in: