Why Did the Silicon Valley Bank Crash?
The Silicon Valley Bank (SVB), one of the largest banks in the United States, recently experienced a massive crash. It left many customers and investors concerned about the institution's future. The bank, known for its focus on lending to high-growth technology companies, suffered a significant outage causing its online banking platform to go down for several days.
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Why did the bank fail?
The Silicon Valley Bank (SVB), is focused on providing banking and financial services to technology companies. It has been in operating since 1983. However, in early 2021, the bank experienced a significant crash in its stock prices, leading to concerns about its financial stability. So, what exactly caused the bank's failure? One of the primary reasons for the bank's failure was the downturn in technology stocks and the Federal Reserve's aggressive plan to increase interest rates to combat inflation.
The bank had bought billions of dollars worth of bonds over the past couple of years using customers' deposits as a typical bank would normally operate. These investments are typically safe, but the value of those investments fell because they paid lower interest rates than what a comparable bond would pay if issued in today's higher interest rate environment.
Usually, that's not an issue because banks hold onto those for a long time - unless they have to sell them in an emergency. Unfortunately, SVB's customers became increasingly cash-strapped, because the venture capital funding was drying up, and therefore companies had to tap into their existing funds — which were deposited with SVB. So eventually, Silicon Valley customers started withdrawing their deposits. And the bank had to start selling its own assets to meet customer withdrawal requests.
Because SVB customers were businesses and the, they likely were more fearful of a bank failure since their deposits were over $250,000, which was the US government-imposed limit on deposit insurance. The withdrawals started requiring the bank to start selling its own assets to meet customer withdrawal requests, and SVB sold its bond portfolio at a loss. The losses added up to the point that SVB became effectively insolvent. The bank tried to raise additional capital through outside investors but was unable to find them.
The bank's customers started withdrawing their deposits, and the withdrawals soon turned into a run on the bank. As the bank's customers withdrew their deposits, the bank became increasingly desperate, and it was unable to find additional capital to cover its losses. Bank regulators had no other choice but to seize SVB's assets i.e., the $209 billion in assets and $175.4 billion in deposits that were still remaining at the time of failure.
The bank's lending practices were called into question, with critics arguing that it had been too lenient in its loan approval process. This, coupled with the bank's exposure to high-risk loans and its concentration in the tech sector, created a perfect storm that ultimately led to its crash.
The impact on startups
The recent collapse of Silicon Valley Bank has caused significant disruption and distress to numerous startups. Startups have been hit all over the world. In fact, according to Reuters, Hedge funds are offering to buy startup deposits that are stranded at Silicon Valley Bank (SVB) for as little as 60 cents on the dollar.
Many startups banked with Silicon Valley Bank as their only banking partner. They couldn’t withdraw their money on time, causing further financial instability. The lack of diversification in funds and the absence of an alternate banking partner has left startups vulnerable to the impact of the bank’s collapse. This unfortunate situation is causing significant uncertainty and making it difficult for some to make payroll in the next 30 days.
How can startups mitigate the impact?
One of the first things that they can do is to reach out to their investors and other stakeholders to explain the situation and seek their support. The situation is changing every day, and recently US government has taken a step to make sure that all the capital remains available. This means depositors who have money at the bank will have full access to it. To prevent a similar situation from happening in the future, startups can diversify their funds across multiple banks and financial institutions. This would help them reduce their dependence on a single banking partner and minimize the impact of any potential bank failures.