The Bank Failure Blame Game — Who Is Really Responsible for Silicon Valley Bank’s Demise?

On March 10, the Silicon Valley Bank (SVB) of Santa Clara, California, was closed by California regulators who appointed the Federal Deposit Insurance Corporation as receiver. The failure caught the bank’s investors, customers and funders — and the country — by surprise. This was the second-largest bank failure in U.S. history, behind the failure of Washington Mutual in 2008.  

With the FDIC’s takeover, the bank reopened the next Monday under the new name, the Deposit Insurance National Bank (DINB) of Santa Clara, and resumed most of SVB’s business. The regulators reassured depositors that they’d be paid back in full and could access their money — underscoring after some legislators voiced adamant opposition to a bailout that losses not covered by the FDIC Deposit Insurance Fund would be covered by assessments to the banking industry itself. Yet with the failure, all SVB shareholders suffered a total loss of their investment.  

SVB’s failure was primarily the result of $1.8 billion in market value losses in its large U.S. Treasury bond portfolio. The Federal Reserve, after all, had raised rates by 4.5 percentage points over the previous year, rather than its more typical loan-quality issues. SVB had purchased billions of dollars of longer-maturity Treasury and other securities in 2020 and 2021, when interest rates were low, and the market value of those bonds was crushed when interest rates rose in 2022 and early 2023.  

While the Fed’s higher rates are the proximate cause of this crash, there was another key factor. SVB’s business was almost entirely focused on the tech sector, and in particular on early, venture capital-dependent companies, including cryptocurrency. SVB referred to this sector as the “innovation economy.”   

In contrast, most banks are intentionally much more diversified, and typically focused on less risk sectors for the purpose of risk mitigation. Regulators and rating agencies have long been wary of “monoline banks” — those that fixate on one sector or industry — since, by definition, they will lack risk diversification.  

Notably, there is less opportunity for lending to this “innovation” sector since early-stage venture capital-backed companies are by definition less creditworthy. That’s because they are usually highly unprofitable and require continuous large infusions of new cash from their venture capital investors to reach profitability. The consequence was that SVB’s loans were only a small percentage of its deposits — just over 40 percent most recently, while for similar-sized banks, that figure was typically 75 percent or more.  

Here’s the problem: with loan demand that low, the bank routinely had to invest a large relative amount of its deposits in U.S. Treasury bonds and other securities. Therefore, it was ultimately more — and fatally — vulnerable to the bond value decline triggered by interest rate hikes. Further, and again because of the nature of the sector it was focused on, SVB didn’t have as stable and well-diversified a base of deposits as other institutions. SVB’s sole focus on this sector was to blame for its to low loan-to-deposit ratio and its vulnerable, business-heavy deposit base.  

The inflation that resulted from COVID-impaired supply chains and supply disruption from the Ukraine war compelled the Fed to begin raising interest rates in spring 2022. With the rise in interest rates, SVB’s bond portfolio plunged in value. By 2023, SVB’s $21 billion bond portfolio was yielding a mere 1.79 percent, while the 10-year Treasury yield had increased to 3.9 percent. And the unrecognized loss from the decline in the market value of SVB’s bonds was poised to wipe out its capital.   

An analysis showed that if those losses were fully recognized, it could take the ratio of SVB’s primary regulatory capital — the core financial buffer a bank is required to have to absorb losses and protect depositors — from 12 percent of assets down to zero. Meanwhile, deposits were continuing to decline, and SVB management was wrestling with other issues, including in their words, “expected continued higher interest rates, [and] pressured public and private markets.” They may indeed have been wrestling with these issues, but not, it seemed, with warranted speed and urgency given the magnitude of the problems they were facing.  

Then came the coup e grace for SVB — the downgrade from the rating agencies. Ratings give potential and existing depositors, funders, and investors assurance that the funds they are providing are secure. Just days before SVB’s failure, Moody’s called to advise the bank that it was considering a ratings downgrade. If SVB management hadn’t yet seemed hyper-focused on this issue, the Moody’s call jolted them into action.   

They initiated a two-part plan. The first was to sell $21 billion in securities to have cash available to meet a deposit run on the bank. It accomplished this by Wednesday, March 8, but took a $1.8 billion loss in the process, causing its capital ratio to plunge below the regulatory requirement. The second part of the plan was to raise $2.25 billion in new capital from investors. SVB had a $500 million preliminary commitment to present to Moody’s and other prospective investors as evidence of progress. But world of its capital need spread quickly once SVB and the invest bank it had hired, Goldman Sachs, were reaching out to so many investors to solicit capital.   

Then the two things that SVB feared most happened: a major run on deposits began, and the bank was unable to raise the remainder of the needed capital. SVB shifted gears immediately in the precious hours they had left and tried to find an outright buyer for the bank, but given the absence of time and the many uncertainties, that effort failed just as quickly. On Friday, March 10, California regulators closed the bank, wiping out shareholders. Immediately after that, Moody’s announced it had downgraded the bank all the way to default, and S&P followed suit.   

The fact that SVB had to act with such flailing desperation meant it hadn’t undertaken risk forecasting and planning. It could have hedged its interest rate risk from the outset; it could have procured emergency sources of funding early on to tide it over in just this sort of situation; and it could have even laid off or discouraged the accumulation of deposits to avoid this very imbalance.   

But SVB didn’t pursue these preemptive moves because such moves are shunned. They are shunned because, like any form of insurance, they are expensive. But in the view of conservative practitioners in the banking industry, that expense is a necessity.  

The failure is just the latest example of how we haven’t learned to give risk its proper due — even when it’s illuminated like a blinking neon sign against the dark skies of ensuing disaster. Why didn’t the rating agencies and regulators act sooner? Any market participant or regulator with a basic ability to read financial statements could have seen the issues with SVB. Yet Moody’s rating for SVB signaled “moderate credit risk” until mere days before its failure. As for regulators, the California state regulators may not have intervened forcefully and early enough, I suspect, because they were inclined to give them the benefit of the doubt. Regulators aren’t oriented toward intervening in a preventative manner, but are best equipped to intervene after an institution crosses below regulatory capital thresholds.   

In regards to the question haunting the minds of Americans — whether the failure is a harbinger of more pervasive and systemic national economic problems — the short answer is no. As Moody’s highly respected chief economist Mark Zandi stated, “The system is well-capitalized and liquid as it has ever been, [and] the banks that are now in trouble are much too small to be a meaningful threat to the broader system.” 

Written by Richard Vague.
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