The Collapse of Silicon Valley Bank and the Problem of How Banks Invest Their Customers’ Money

On Friday, March 10, 2023, Silicon Valley Bank (“SVB”)- a mainstay of the Silicon Valley startup and venture capital scene- collapsed and was put under the control of the Federal Deposit Insurance Corporation (“FDIC”). The sudden and stunning collapse of SVB is the largest banking failure in the U.S. since Washington Mutual collapsed in 2008 and the second largest banking collapse in U.S. history.

The collapse and subsequent government intervention came after SVB announced it had sold a large quantity of securities (at a loss of approximately $1.8 billion) and as a result was selling $2.25 billion of its own shares to stabilize its balance sheet. On this announcement, SVB stock lost almost half its value in a single day – causing a panic among venture capital firms. In the days prior to the March 10 collapse, these firms reportedly advised large SVB customers to immediately withdraw their assets. This led to a rapid run on the bank that left it unable to meet its financial commitments, forcing the government to intervene. 

Given SVB’s position as a bank of choice for venture capital and start-ups, news of the collapse and government take-over sent panic waves throughout the finance sector and Silicon Valley. This was only alleviated on the morning of Monday, March 13 when the Treasury Department, the Federal Reserve, and the FDIC issued a joint statement declaring that all depositor’s funds would be covered at no cost to the taxpayers. The government’s announcement headed off a potential devastating week for many start-ups with assets in SVB – as they were at risk of losing the liquid capital necessary for ongoing operations. The announcement also stemmed a potential chain reaction of similar bank runs.

While the government’s swift intervention prevented a possible financial crisis, the question echoing throughout Wall Street and the media alike is “what happened?” The answer is a complex one involving federal economic intervention and a potential significant weakness within the U.S. banking system.

As a bank that attracted a considerable amount of investment-type customers in the tech industry, SVB saw its cash deposits skyrocket with the growth of venture capital-backed tech start-ups. By the end of 2022, SVP was holding $209 billion in assets and had become the 16th largest bank in the U.S. However, as is standard in the banking industry, SVB only kept a small portion of its customer deposits in cash available for immediate withdrawal. The majority was either lent out to other customers or invested. In the case of SVB and many other banks, most of these investments were in low interest-bearing U.S. Treasury bonds.

Normally, U.S. Treasuries are considered safe investments. However, in an aggressive attempt to combat inflation, the Federal Reserve unexpectedly increased interest rates in early 2023. As a result, existing U.S. Treasury bonds with lower interest rates (like those held by SVB) lost a substantial amount of value as they could not compete with newer high interest-bearing bonds. For banks like SVB that catered heavily to the venture capital industry, this proved especially problematic. Not only were the bank’s investments underwater, the government’s rate hikes also led to a considerable slowdown in the venture capital market – resulting in a sizable drop in new customers and deposits to the Bank. As SVB was not bringing in enough new deposits to cover its customers’ withdrawal requirements, the Bank was forced to sell its U.S. Treasury positions at large losses. The sudden and unexpected run on the bank in those conditions was devastating as the Bank did not have the cash on hand to cover all deposit requests and stay solvent.

The collapse of SVB has already prompted one securities class action lawsuit. On March 13, 2023, SVB shareholders filed a federal securities class action in the U.S. District Court for the Northern District of California against SVB’s parent company, SVB Financial Group, former SVB CEO Greg Becker, and Chief Financial Officer Daniel Beck. The case was filed on behalf of all persons and entities who purchased or otherwise acquired publicly traded SVB securities between June 16, 2021 and March 10, 2023.

The class action, captioned Vanipenta v. SVB Financial Group, et al, alleges Defendants violated sections 10(b) and 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder, by making materially false and/or misleading statements in the company’s public filings regarding the impact of interest rate increases on SVB’s business. Specifically, the complaint alleges that in multiple public filings, the Company failed to disclose that (1) rising interest rates posed a material risk to the Company, (2) in a high interest rate environment, SVB would be worse off than banks that did not cater to tech startups and venture capital-backed companies, and (3) if investments were negatively affected by rising interest rates, SVB was particularly susceptible to a bank run. The complaint seeks an unspecified amount in damages.

As the saga of SVB has come to demonstrate, banks that heavily invest in low yield Treasury Bonds will be particularly susceptible to sudden and unexpected interest rate changes. This is especially true for banks that cater to volatile industries such as venture capital.  This is an overlooked and systemic issue within the banking industry that is sure to be topic of conversation for some time to come.

The information above is not intended to and should not be construed as specific advice or recommendations for any individual. The opinions voiced are for general information only and are not intended to provide, and should not be relied on for tax, legal, or accounting advice. To discuss specific recommendations for any unique situation, please feel free to contact us.

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