Silicon Valley Bank collapse: 4 key takeaways from the bank's downfall

The second-largest bank failure in US history took place last Friday, sending startups and investors of Silicon Valley and the world into shock

On Friday, Silicon Valley went into a panic as one of its top banks collapsed, along with its roughly $209 billion in assets.

Silicon Valley Bank (SVB) was best known for serving major players in the tech world, from online gaming platform Roblox to VC bigwig Andreessen Horowitz. In recent years, it also began serving a number of crypto companies, including Yuga Labs, the company behind the Bored Ape Yacht Club NFT collection, and Circle, an issuer of stablecoin USDC.

According to the National Venture Capital Association (NVCA), the bank also had more than 37,000 small businesses with over $250,000 in deposits. When news of the bank’s failure hit, many of them were left wondering how they would be able to continue paying their employees.

“This is an extinction-level event for startups,” said Garry Tan, the president and CEO of Y Combinator, a startup accelerator that has launched companies such as Coinbase, Airbnb, Dropbox and Reddit.

Over the weekend, US regulators assured SVB’s customers that they will have access to all of their deposits starting Monday, March 13, and set up a new facility to provide banks access to emergency funds.

On Monday, HSBC announced that it had acquired SVB’s UK unit for £1.

As the situation continues to develop, here are four key takeaways to chew on.

People queue up outside the headquarters of Silicon Valley Bank to withdraw their funds on March 13, 2023 in Santa Clara, California (Photo: Liu Guanguan/China News Service/VCG via Getty Images)

Above People queue up outside the headquarters of Silicon Valley Bank to withdraw their funds on March 13, 2023 in Santa Clara, California (Photo: Liu Guanguan/China News Service/VCG via Getty Images)

1. This was the second-largest bank failure in US history

The largest American bank failure took place at the height of the Great Recession. In 2008, Washington Mutual, which was reportedly the country’s largest savings and loans bank at the time with about $309 billion in assets, collapsed. It had been dealing with incredible losses from risky mortgage lending and a run by its depositors, which happens when customers withdraw their money because they believe that their bank might fail.

In the US, banks are required to keep a liquidity ratio—a measure of a company’s ability to pay debt obligations—of 10 percent. This means they are allowed to leverage up to 10 times their user’s deposits to lend out or make other forms of investments.

During a credit crunch, which is typically led by an increase in interest rates and a drop in the supply of money in the economy, a run could destabilise a bank and cause it to go bust.

2. It was largely triggered by rising lending rates

Financial leverage—the strategy of using borrowed money to increase the potential return of an investment—is arguably the fastest way to financial freedom as well as Armageddon. It can have serious consequences when misused. Some believe it was a factor that caused the 2008 Global Financial Crisis.

When lending rates go up, the breathing room becomes tighter and companies may have to sell off some of their assets, sometimes at a loss in order to pay off the debt that they owe.

In the case of SVB, it had sold about $21 billion of its bonds at a $1.8 billion loss. When the bank disclosed this, billionaire entrepreneur and investor Peter Thiel’s Founders Fund and a few other renowned VC funds took notice. They then reportedly advised their portfolio companies to pull their deposits from SVB, which led to an eventual run on the bank starting Thursday.

3. It is unlikely to cause a financial contagion

The amount of leverage in venture investing constitutes a fraction of the mortgage-backed securities, which were what the “Wolves of Wall Street” peddled as low-risk investments back in 2006. For risk-on assets with a high rate of return, such as venture investments, it’s typical that less money will be raised on debt to fund them.

It is also unlikely that there will be pension funds and other financial institutions to provide insurance on the failure of those assets, which was what caused the cascading failure of top US financial institutions in 2008.

According to analysts, tighter US regulations put in place after the 2008 financial crisis has helped to limit the risk of financial contagion. This included mandating major banks to hold extra capital in case of trouble. “Our banking system is in a fundamentally different place than it was decades ago,” said Cecilia Rouse, chair of the White House Council of Economic Advisers, at a briefing on Friday.

A note from analysts at Morgan Stanley also said that “we do not believe there is a liquidity crunch facing the banking industry, and most banks in our coverage have ample access to liquidity.”

4. It could speed up the adoption of decentralised finance

For people looking in, the world of cryptocurrencies is laden with rampant fraud and illicit activities. But the projects that have stuck to the ideals of decentralisation are still standing strong despite the liquidation events of 2022.

Decentralised systems are meant to be trustless, so a breach of trust cannot happen in the first place. The breach of trust only happened with a handful of centralised players, who gambled their customers’ deposits away.

When crypto hedge fund Three Arrows Capital defaulted on a payment for a $670 million loan it made from trading platform Voyager Digital, the collaterals that were deposited on decentralised lending platforms such as Aave were liquidated like clockwork to make the lenders whole.

Banking is centuries old and has gone through a series of regulatory and compliance transformations over the ages. But rampant risk-taking by the people running it continues, some of which have led to serious crises. While not perfect, decentralised finance is more transparent, efficient and free of the agency problem that affects traditional finance, which may make it even more appealing at this point in time.

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4 things to know about the Silicon Valley Bank collapse

1. This was the second-largest bank failure in US history

2. It was largely triggered by rising lending rates

3. It is unlikely to cause a financial contagion

4. It could speed up the adoption of decentralised finance