Silicon Valley Bank (SVB) – Systemically Very Bad?

Markets have been in shock after Silicon Valley Bank (SVB) failed and was taken over by regulators last week. The failure was caused by poor risk management and lack of diversification in funding sources, leading to vulnerability to a bank run. Regulators declared SVB systemically important and guaranteed all deposits, creating a new lending facility to prevent future bank runs. The market reaction to this failure has been negative, with bank stocks and broader equity markets falling, with Credit Suisse being particularly impacted by the news. However, the situation is still unfolding, meaning the market impact may change over time.

What happened to the bank?

To understand what happened to the bank it is useful to know the basics of a bank balance sheet.



Long-term Securities (US Govt. Treasury Bonds) Deposits
Long-term Loans to businesses Short-term borrowing

Banks make money by owning assets and funding them with the money they get from depositors, along with short-term borrowings. Deposits are like loans from the depositors to the bank, but depositors can demand their money back at any time. If a bank gets more deposits than it can lend out, it puts the extra money into safe investments like government bonds. There is also a regulatory minimum holding of safe assets.

The bank holds government bonds in two different groups. One group is called "Available for Sale" (AFS), and the other is called "Hold to Maturity" (HTM). The AFS bonds can be protected against changes in interest rates, while the HTM bonds cannot. When the bank records the value of its bonds on its balance sheet, it can either use the market price of the bond (AFS) or assume it will be held until it matures and price it based on the interest received by the bank (HTM).

When the bank invests in the AFS bucket and the market value of the securities goes up or down, the gains or losses are recorded. However, these gains or losses do not directly impact the bank's profit or loss statement. Instead, they are recorded in a separate account, called the Other Comprehensive Income (OCI) account, which is a part of the bank's equity. These losses/gains impact the capital buffers used to insulate against loan losses but do not impact the bank's profit or loss statement.

On the other hand, securities held in the HTM bucket are not marked to market, which means that the changes in the market value of the securities do not impact the profit or loss nor the capital buffers of the bank. This is because the HTM securities are held with the intention of being held until maturity, and any change in their market value is not relevant unless the bank intends to sell them before they mature.


Figure 1. SVB Client Funds Breakdown. (Source: SVB Annual Report, 2022)

Now, let's look at SVB. As the main banker for technology venture capital, SVB has a lot of money from a small group of depositors. Typically, banks serve many different types of customers, so if one group withdraws money, it doesn't affect the bank too significantly.

Figure 2. SVB Client Funds Inflows/Outflows vs VC Activity. (Source: SVB Annual Report, 2022)

The graph above shows how this deposit base profile impacted outflows. Because many of these VC backed firms were not yet profitable, they relied on fundraising inflows to balance the cash burn. As interest rates rose VC fundraising slowed and failed to balance the cash burn outflows.

Figure 3. SVB Insured Deposits. (Source: Apricitas Economics, 2023)


Figure 4. SVB Assets. (Source: SVB Annual Report, 2022)

As explained previously SVB had a choice between holding its assets in a HTM bucket or an AFS bucket.  It chose to place 44% in HTM, which means those securities couldn't be protected from changes in interest rates. This decision was made to avoid reporting losses on those securities in their financial reports. The bank could have protected the other assets in a bucket called AFS, but they didn't in 2022. This was a risky move, particularly as the Federal Reserve had signalled that interest rates would be rising to deal with inflation. The bank claimed that hedging would hurt their profit margins, but this turned out to be a costly mistake. 

The final nail in the coffin

Some depositors became worried about the bank and started withdrawing their funds. To meet these demands, the bank was forced to sell some of its AFS securities and raise capital by selling new shares. This caused other depositors to panic and withdraw their funds, resulting in a total of $45 billion being taken out of the bank in just one week. The bank was unable to fulfill these requests, as the HTM assets to which they were too heavily exposed could only be sold at discounted prices due to the higher interest rate environment and hence SVB was shut down. It was a classic bank run, but it was caused by the bank's poor risk management, greed, and lack of diversification in funding sources.  This could be interpreted as poor management afflicting one bank rather than a systemic crisis. 

What was the regulatory response?

After the bank's failure, regulators took quick action. The Federal Reserve, FDIC, and Treasury Department declared the bank to be systemically important and guaranteed all deposits, including those that were uninsured. To prevent future bank runs, the Fed created a new lending facility that allows banks to use HTM bonds as collateral for borrowing at face value instead of market value. This is important because it means that banks can access funds to fulfill withdrawal requests even if the value of their HTM bonds has fallen below market value, thus avoiding the liquidity issue which compromised SVB. At a systemic level, we expect this to avert a 2008-style crisis.

Impact on markets?

The market reaction has been swift, with global bank stocks and broader equity markets falling. Credit Suisse, in particular, has been hit hard, and the Swiss National Bank has stepped in with liquidity guarantees. In sovereign bond markets, traders have significantly increased their exposure to short-term Government debt, anticipating that Central Banks will soon cut interest rates to preserve financial stability. Credit markets have also tightened, as investors expect small regional banks to lose deposits to larger banks, impairing their ability to generate credit. It's important to note that these reactions are based on expectations and may change as more information becomes available. The situation is still unfolding, and it will take time to assess the full impact on the market.

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Note: This Market update is for general information only, does not constitute individual advice and should not be used to inform financial decisions. Additionally, past performance is not a guide to future returns. Investment returns are not guaranteed, and you may get back less than you originally invested.