Silicon Valley Bank fell apart in the space of 36 hours—marking yet another financial debacle in the industry. The collapse of the Valley’s numero uno financier spells big trouble for startups around the world—and their employees. Worse, it also raised fears of ‘contagion’—as a second bank went out of business over the weekend. In part one, we look at what happened—while part two will focus on the big ‘why’.
What’s this bank, now?
Founded in 1983, the Silicon Valley Bank focuses almost entirely on the tech industry—and it was tightly woven into the global startup economy. Nearly half of all US VC-backed startups are its customers—as are a number of prominent VC (venture capital) firms. And it was the banker for 44% of US VC-backed tech and healthcare companies that went public last year. SVB called itself the “financial partner of the innovation economy.”
A dizzying rise: The rise of the tech industry fuelled SVB’s breakneck growth in recent years. The Valley was flush with investor money—and most of it was deposited in SVB. The bank ended the first quarter of 2020 with just over $60 billion in total deposits—which jumped to just shy of $200 billion by the end of the first quarter of 2022.
FYI: Its collapse marks the second-biggest bank failure in American history. Point to note: SVB still had more than $200 billion in assets when it collapsed.
How did such a big bank collapse?
To understand that, you have to first know the relationship between bond prices and interest rates. We pinky promise to keep this really, really simple.
SVB hearts bonds: Bonds are way safer and less volatile than stocks—and government bonds even more so. SVB took the majority of the cash deposits and invested it in bonds—primarily longer-term US Treasury and government-backed securities. Its bonds portfolio grew at almost the same dizzying pace as its deposits—climbing from about $27 billion in the first quarter of 2020 to around $128 billion by the end of 2021.
Enter, the Federal Treasury: The US has been struggling with soaring inflation. The Fed has tried to cool down prices by repeatedly hiking interest rates. In other words, borrowing money to spend has become more expensive. And saving money earns you a higher rate of interest.
The problem with bonds: Now, when you buy a bond, it pays a fixed interest rate for a certain period of time—which protects you from volatility in rates. But SVB bought all its bonds just before the Fed went on its interest rate-hiking spree. With each rise in interest rate, the new bonds offered a better return. And bonds that offered the old, lower rate became less valuable—if you were to sell it in the market.
In the case of SVB, the gap between the cost of its securities and their market value jumped to more than $17 billion by the end of 2022. None of this would be a problem if SVB could have waited until the bonds matured—by when the interest rates may well have gone down.
SVB’s liquidity problem: Over the past year, the era of lavish VC funding has come to an end. Since it is harder to raise money, startups have been forced to spend the money they have in the bank. And with interest rate hikes, the new deposits cost the bank more money. As a result, its deposits fell from nearly $200 billion at the end of March 2022 to $173 billion at year-end 2022. And the company expected this downward trend to continue in the immediate future.
The great announcement: Last Wednesday, SVB decided to assure everyone that it is doing its dutiful best to shore up its balances. One, it was going to swallow a big $2 billion loss by selling $21 billion of its securities—but it would bring in more cash. Two, it would sell $2.25 billion in new shares. Voila, SVB would have enough cash to get through this lean period.
The terrible timing: Unfortunately, SVB made the reveal right after the big crypto bank Silvergate announced that it was shutting down. Now, Silvergate’s problems had zero connection to SVB’s bond dilemma—but the tech industry was already jittery. And the messaging was just as terrible—with [CEO Greg] Becker telling everyone not to “panic”: “My ask is just to stay calm, because that’s what’s important.” People panicked. As one customer explained: “It’s like the end of ‘Animal House.’ Don’t panic? Now, I am panicking, watching your broadcast.”
The great bank run: A number of leading VCs—Peter Thiel, Union Square Ventures—told their companies to take their money out of SVB. Some of the biggest incubators like Y-Combinator were doing the same. The result: customers pulled out $42 billion in just one day—a quarter of its cash balance. Needless to say, SVB’s stock price also tanked as a result—putting an end to the plan to sell new shares. The company ran out of money—and two days later, March 10, federal regulators shut it down.
The biggest and most trusted bank in Silicon Valley collapsed in the space of 36 hours—brought down by its panicked customers:
Silicon Valley Bank was in “sound financial condition prior to March 9,” according to an order from California’s Department of Financial Protection and Innovation. It became insolvent after investors and depositors caused a run on its holdings, the order said.
This must be a total disaster for startups…
Yes, especially since it comes right as investor funding is drying up. But the bigger fear is that other banks will be brought down by panicked customers.
The fallout: Typically, the government only covers up to $250,000 in losses. Depositors who hold uninsured funds are issued a “receivership certificate”—which entitles them to future payments as and when regulators sell SVB’s assets. Nearly 90% of SVB’s deposits—adding up to $151.5 billion—were uninsured.
A number of big tech companies have large chunks of money tied up in SVB—like the gaming company Roblox and streaming platform Roku. But the most vulnerable are the smaller startups—founded in the last couple of years. Many of them are struggling to make payroll:
“The impact of the SVB incident on the technology industry should not be underestimated,” analysts led by Liu Zhengning at China International Capital Corp. said in a note. Deposits are crucial for tech startups because they generally require a lot of cash to pay for hefty expenditures including research and development costs and staff salaries, they said.
Point to note: The full exposure of these companies and their employees will become clearer in the coming days—and it may go far beyond just corporate woes. One entrepreneur says:
They would not only be the corporate lender and corporate bank for your startup, they would also provide a mortgage for your house as a founder. They would be your personal wealth manager. They’re very highly integrated in a lot of aspects of founders’ lives.
The contagion effect: Trading in stocks of First Republic Bank and Signature Bank was halted on Friday morning—after First Republic shares fell by 52%. But it wasn’t sufficient to save Signature—which lost billions on Friday as jittery customers withdrew their money. The bank was taken over by New York regulators on Sunday. Another investor darling, it became the number one lender to crypto companies—which have been tailspinning in recent months (See: Our Big Story on FTX). Despite moves to diversify its base, Signature wasn’t able to prevent the bank run.
Beyond Silicon Valley: According to one economist: “There’s always a risk of contagion, because banking is fundamentally a game of trust and confidence. When they erode, the system becomes less stable.” That said, the bigger banks have a more diversified customer base—i.e are not entirely reliant on tech companies—and have spread their investments bets beyond bonds unlike SVB.
As for India: The SVB meltdown has had reverberations around the world—from Singapore to Shanghai and Bangalore. A number of Indian tech startups—especially those providing software-as-a-Service (SaaS) to US clients—have accounts at the bank. Also this: startups backed by incubators like Y-Combinator must have a US account to receive funding—and SVB allowed these companies to set up accounts without a social security number. Of the 200 startups backed by Y Combinator, 64 have uninsured deposits with SVB.
Leading banks—Axis Bank, Kotak Mahindra Bank, ICICI Bank and HSBC India—have assembled teams to help founders move their money out of SVB into dollar accounts in Gujarat GIFT City. Payment companies like Razorpay have jumped into the fray, as well.
So what happens now?
The collapse of two massive bank failures in the space of two days pushed the government into announcing an emergency plan.
The emergency plan: The Federal Reserve’s emergency funding program will freely lend money to banks—so that they have the money to pay depositors. So they don’t have to sell their bonds in a hurry—but use them as collateral for these loans instead. Thanks to Uncle Sam’s generosity, customers of SVB and Signature will be able to access their money today. Most experts think this should be sufficient to calm a panicked Silicon Valley.
Quote to note: Leaders of the notoriously regulation-averse tech industry were the first to demand an immediate government bailout:
Garry Tan, chief executive of Y Combinator, one of the industry’s most influential start-up incubators, tweeted that failure to act could represent an “extinction level event” for start-ups and could set back innovation “by 10 years or more.”
Then there is Elon: Please note that the tech billionaire is “open” to buying SVB as part of his great Twitter experiment—to turn the platform into a digital bank.
As for India: The Finance Ministry isn’t worried—and says the contagion is unlikely to trigger “systemic risks”—and will only affect individual startups.
The bottomline: The more interesting question about the SVB collapse is this: who is to blame? The management, government or Silicon Valley? The answers will likely determine the future of an industry in crisis. We lay out that debate in part two.
Reading list
Vox, Wall Street Journal and Bloomberg News have the best overviews. Associated Press has details of the emergency funding plan. Washington Post looks at the debate over the bailout. Mint and Indian Express have more on the impact on India. The Hindu reports on the Indian government’s view of the crisis. TechCrunch argues SVB’s announcement brought this calamity on itself. Reuters has an excellent analysis on why this spells the end of cheap money in tech.
