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Why Banks Fail: The Collapse of Silicon Valley Bank

Biz Money

Another day, another bank run. Oh wait, this isn’t 2008 still… but after this past weekend, it may have felt like it. Let’s talk about why banks fail and what the heck happened with Silicon Valley Bank.

How exactly does a bank work?

From the consumer’s perspective, a bank is pretty straight forward. We give them our money, and when we want it back, they give it back to us.

But from the back end, a bank’s operations are a little more complex. In order to make money, the bank takes our money and invests it. This allows them to make money (business gotta business, ya know). This also means that not 100% of the bank’s deposits from customers are “liquid” (or available) 100% of the time.

There are rules around how much cash banks have to keep liquid, so that in the event a lot of people want their money bank, a bank is not sh*t up a creek. But what happens when everyone wants their money bank?  What makes banks fail?

What is a bank run (or a “run on the bank”)?

When everyone (or a large majority) of customers want their money bank, they create a run on the bank. The bank doesn’t have enough cash to satisfy these withdrawal requests and it has to cash in its investments (often at a loss), and even then it may still not have enough money to satisfy its customers (this happens when their investments have taken larger losses).

What is Silicon Valley Bank (SVB)?

Basically, a bank for startups. It’s the 16th-largest bank in the US and had $209 billion in assets at the end of 2022. Nearly all of those assets came from tech startups and investors.

So what the hell happened? Why did a bank fail in 2023?

Late last week, SVB announced that it was trying to raise funds because it was having a capitalization problem (meaning, not enough cold, hard cash on hand).

This freaked out its customers, who basically all panicked and scrambled to take their money out. Cue the run on the bank.

As a result, Federal regulators took over the bank (yes, they can do that) on Friday to stop the bleeding. This resulted in the 2nd largest failure of a bank in basically, forever, and the largest failure since the death of Washington Mutual in 2008.

OK but WHY did this happen? Why do banks fail?

SVB’s problems go further back than last Friday. As I noted above, banks invest their customers’ funds to make money. Unfortunately for SVB, a few factors made this particularly challenging over the last year

  •  The Federal Reserve has been raising interest rates, which means SVB’s customers (tech companies) faced higher borrowing costs and therefore needed more of their cash to pay their bills.
  • One of the investments SVB favored were long-term bonds, which are actually fairly safe. But they bought a lot of these back when interest rates were super low. So SVB’s investments weren’t returning them a whole ton of money (I’ve seen the figure of an average yield of 1.79% thrown around).

To combat their sad balance sheet, SVB sold many of its securities at a loss and announced it would sell $2.25 billion in new shares to bring in more cash. There’s nothing customers love hearing more than “we sorta don’t have that much money so can you please give us more?” Whoopsie.

What happens now?

The FDIC insures bank accounts up to $250,000, so federal regulators have said they expect customers to have access to the insured portions of their accounts by today.

And then in a blink-and-you’ll-miss-it hail Mary that only seems to occur when wealthy white guys are in trouble, the government announced that they would cover ALL of the deposits in the bank, whether or not they had been insured. (Side note: This is coming at “no cost” to taxpayers, as the funds will be taken from the FDIC’s deposit insurance fund).

Great, but how does this affect me?

Unless you held your funds at SVB or work at a tech startup, it probably doesn’t. At least not short-term. Most experts believe that this is an isolated incident and not a systemic failure of the US banking system. And some have argued that this actually shows the FDIC and US banking system working – when times get tough, we have the right protections in place to prevent chaos.

Given the government’s late-Sunday-night relief for all SVB depositors, we likely won’t see mass layoffs in the tech industries that we were expecting when this all happened last Friday. But it wouldn’t surprise me if we still see some shake-ups – this has affected tech stocks and confidence in the VC-backed world. Thankfully, it’s still not every day that banks fail.

If you invested in the stock market, you may see some short-term dips. But remember that investing is a long-term gain so don’t rush to pull your funds out at a loss.

And if you happen to have more than $250,000 in one bank, change that fast. While the government backed 100% of deposits in this case, there is no guarantee that they will do it next time. Wondering how to set the money stuff up right in your business and minimize your liabilities? Join our Biz Money Library.