Silicon Valley Bank: What now?
By: James Ward & Dara Tarkowski
The worrying news about Silicon Valley Bank that’s emerged over the past week or so has left investors, retail banking customers, and small businesses alike in a state of confusion and fear. Many felt that this week would begin with the possibility of a substantial number of runs on banks in the United States and the United Kingdom. Swift action by the FDIC -- and other banks -- have staved off the risk of a run, at least for now. But the prospect of contagion looms, and the question that any business in the tech space are asking is -- what happened? and what happens next?
Twenty-five years ago this scenario would have been unthinkable. Nothing was safer than placing your money in the bank -- at least since 1929. The safeguards put in place in the wake of Black Friday allowed generations of Americans and American small business owners to rely on the surety of their cash in depository institutions. Regulatory changes in the 90’s and administrative guidance in the years since then fundamentally altered some of the bases for that confidence. The re-merging of investment banking and commercial banking set the stage for integration at a scale previously unimaginable. That, along with increased institutional consolidation in the wake of the Great Recession led to a place where, today, more power and more assets are held by fewer banks than at any point in history.
How then, is it possible for there to be such a rapid collapse of one of the largest banks in the world who played such an integral role in the innovation and entrepreneurial community?
The same way that many banking collapses happen: something we call "Inevitability Syndrome." What do we mean by this? Banks like SVB consumed enormous quantities of quantitatively eased dollars between 2008 and 2018. During that period, it was almost impossible for banks to go under if they were well capitalized, because their balance sheets reflected massive liquidity infusions in a low interest-rate environment. The rates that banks could get on money loaned out were almost always better than the rates investing in federal tresury bonds, yes, but the returns on funds invested were even better. As a consequence, there was no reason to ever hold onto the money that the banks held because the returns elsewhere were so obvious, so attractive, and so easy to secure. Putting that money on the balance sheet in the form of an investment was, to the banks, the equivalent of a sure thing. It was inevitable that the prices, and the returns would be strong.
The problem with Inevitability Syndrome is that it looks an awful lot like hubris. The assumption that things are as they always will be is the kind of risk that commercial banks simply cannot take. Here, SVB put billions into mortgage backed securities (MBS), and assumed the return MBS returns over 10 years would be quite strong. And in fact, had the bank been able to meet short term needs on capital draws, those returns probably would have been substantial. But higher interest rates led investors to want to shift their own holdings to Treasuries and other secure bonds. Enough of those decisions made at once led to unexpectedly heavy cash draws (although, it must be said, not unprecedented). SVB found itself on the wrong end of a squeeze, and within a week the bank was no more. Too add insult, we’ve now learned that SVB’s CEO sold $3.6M in SVB stock just before the collapse was announced. We’ll see if the lawmakers are able to secure the return of those funds.
So what should you, as a customer, do? Is it time to split up all of your bank holdings across dozens of banks, so that none are ever over the 250,000 FDIC insurance limit? Although some are suggesting this as a strategy, we would classify that, in technical terms, as "not a good idea." For a company managing payroll, expenditures, and all other manner of expenses via a multi-party banking miasma is no solution. Instead, thoughtful companies should take a reasoned approach to responding to the SVB crisis. Here are three straightforward steps to consider.
1. Vet your bank before you open an account and establish your commercial relationship. Do your due diligence on your banks before you make a large placement or start a relationship. Although it’s not always the case that you can secure the information you need some diligence is always better than none.
2. Continue to vet your bank. It's not enough to have a good experience when you begin a relationship. The first few dates are always so magical, right? Often, businesses open those accounts when their needs were quite different. So it makes sense to think about your banking as another service that you have to evaluate on an ongoing basis. While no one should just abandon a banking relationship for the fun of it (spoilers: that's not fun), examining how your bank is doing today and what they're doing for you today is a smart move.
3. Consider smaller, more responsive banks. The banking world may be filled with behemoths, but there are a wide variety of outstanding, responsive, forward-looking smaller and medium sized banks that can provide services to companies that match what larger banks can do. More than this, because they are smaller, they are often more responsive to client needs. This is not always the case and you should do your homework first, (see suggestion No. 1) but a bank that knows you, and your needs, is not a bad thing by any means.
There's no way to eliminate risk, of course, and systemic banking problems would affect everyone. But a concerted, informed, thoughtful approach to being a banking customer is the right move, regardless of what's on the news.