The unsettling banking headlines this week evoked memories of 2008 as well as the classic bank run scene from It’s a Wonderful Life where the Bailey Building & Loan reaches the brink of collapse. Jimmy Stewart’s character, George Bailey, reassured his customers that their assets were invested in a diversified pool of local businesses and mortgages. Silicon Valley Bank, in contrast, did not have a well-diversified asset base or a charismatic leader to reassure local depositors.
As concerns about their capital position arose late last week, the FDIC stepped in to take control of Silicon Valley Bank. So far, their actions have been effective. The broad stock market has remained fairly resilient, with investors recognizing that the issues facing specific banks aren’t representative of the entire industry.
As we unravel Silicon Valley Bank’s problems and subsequent relief efforts, there are a few key lessons to highlight.
Lesson #1: Diversification Matters
Silicon Valley Bank had several missteps in management over the last year, but the cardinal sin that they committed was a lack of diversification. The bank’s customer base was located in a single region, concentrated in one industry, and in one segment within that industry. SVB was purportedly the bank of choice for an estimated 50% of all startups, arguably the riskiest end of the technology sector, and custodied assets for many private equity and venture capital funds.1 This tech-centric customer base, whose financial assets ballooned in recent years, lacked the diversification that creates resiliency.
That risk was exacerbated by the fact that most of their customers were part of the same networks or working with a concentrated handful of prominent venture capital firms. This meant that when the large VC firms got nervous about SVB, they instructed hundreds of their portfolio companies to withdraw their cash at the same time. The panic that spread via Twitter and text messages led to $42B of attempted withdrawals in a single day – a pace that almost no bank could withstand.2 For this reason, SVB was more susceptible to a bank run than other banks with diversified customer bases that don’t know each other and don’t take instruction from a small overlapping group of advisors.
On a positive note, the sometimes-abstract concept of diversification became very tangible for investors with diversified portfolios. Most investors in the US had direct exposure to Silicon Valley Bank because the bank was part of the S&P 500 index. At North Berkeley, our clients, too, had direct exposure to Silicon Valley Bank in their equity portfolios. Importantly, though, this represented less than one-tenth of one -percent (<0.01%) of our client’s investments. While we rarely expect a company of this size and prominence to fail so dramatically, we protect our clients from these risks by remaining diversified.
Lesson #2: The Success of the FDIC
This crisis has reacquainted many people with the FDIC, which was originally created in 1933 by FDR to protect depositors and restore trust in the banking system following the Great Depression. For the past 90 years, it has steadfastly accomplished this mission, navigating changes in our complex economy and interconnected US banking sector.
The size of the Silicon Valley Bank collapse vaulted the FDIC into the headlines, but it was hardly the first time it needed to spring into action. In the last 20 years alone, since 2003, there have been 548 bank failures where the FDIC has needed to step in.3 This represents hundreds of banks with too little capital, nervous depositors, and events with a potential for panic. In every case, insured depositors never lost money. The FDIC identifies troubled banks and then brokers a deal to sell the bank to another stronger bank buyer in a swift and orderly manner. The vast majority of these bank takeovers didn’t make national news, largely because of how effective the FDIC is at managing these transitions.
Despite mostly operating behind the scenes, the FDIC has done a tremendous amount to maintain consumer faith in the banking industry, which supports stability and continued growth in the broad economy.
Lesson #3: Reduced Regulation Means Increased Risk
Just as the Great Depression gave us the FDIC, the financial crisis of 2008 led to new banking regulations anchored by the Dodd-Frank Act.4 These new regulations, which still apply to the 33 largest banks in the US, require banks to undergo annual stress tests, be subject to closer supervision, and hold increased capital reserves.
That hard-learned lesson helped – for a while. However, in 2018, Congress decided to roll back these regulations for regional banks, including Silicon Valley Bank. Former SVB CEO, Greg Becker, was a major proponent of this reduced regulation.5 Advocates for less regulation argue that it reduces compliance costs and enhances growth and potential return by allowing for greater risk-taking. This tends to work – until it doesn’t. As SVB and other regional banks were no longer subject to annual stress tests and stricter capital reserves in recent years, they grew deposits at a breakneck pace and invested reserves more aggressively, all of which eventually contributed to this recent crisis.
Lesson #4: Speed of Response
Another key lesson is that the speed of response matters to investor sentiment. During the current crisis, the FDIC and the Fed moved swiftly to announce protections for Silicon Valley Bank’s depositors (including uninsured deposits) before the bank re-opened on Monday morning. This helped ensure payroll would be processed on the 15th, protecting employees from thousands of companies with business accounts through SVB. If those steps hadn’t been taken so quickly, the potential for contagion would have been much greater.
In the ensuing days, we’ve seen the banking industry and regulators taking further action to alleviate systemic concerns. Yesterday, J.P. Morgan led a group of 11 major banks that banded together to provide a $30B cash infusion to First Republic Bank, and the Swiss National Bank provided $54B to help shore up Credit Suisse.
There is no definitive playbook for these scenarios, but policymakers and central bankers know that once panic sets in, whether a bank run or a market spiral, there are fewer paths to remedy specific issues and communicate the strength of the system as a whole.
Even with many lessons reaffirmed over the past week, it remains unclear how the current stresses will impact markets over the coming months. Silicon Valley Bank was a major institution in the startup tech world, and its restructuring may slow economic activity until confidence and financing capacity can be rebuilt. Recent weakness in some regional banks may also rekindle efforts to increase banking regulation in order to balance growth with good risk management.
One immediate impact will be seen next week when the Fed is expected to slow down or even pause their trajectory of rate hikes to provide some relief while investors digest recent events. This expectation has helped stabilize markets in the short term, and ideally, their actions will reinforce that. While we don’t know exactly how or where further ripple effects will emerge, two things are clear: higher interest rates are impacting the economy beyond just curbing inflation, and the value of diversification for businesses and investors is as important as ever.
1 An analysis of regulatory filings reveals that 1,074 firms—from Andreessen Horowitz to General Catalyst—were holding capital at Silicon Valley Bank in 2022 Fortune
2 How Silicon Valley Turned on Silicon Valley Bank WSJ
3 Bank Failures in Brief – Summary 2001 through 2023 FDIC
4 Dodd-Frank Act: What It Does, Major Components, Criticisms Investopedia
5 Silicon Valley Bank ex-CEO backed Big Tech lobbying groups that targeted Dodd-Frank, sought corporate tax cuts CNBC
About Brian Kozel, CFP®
Brian Kozel is a Partner at North Berkeley Wealth Management. Brian helps clients feel confident as they navigate their financial journey.
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