Silicon Valley Bank may not fall alone, but it’s unlikely to become a financial crisis

Terry College finance professor explains what happened at Silicon Valley Bank
Lowrise building with the word BANK across the top

Over 48 hours last week, Silicon Valley Bank went from a regional bank with little name recognition outside the tech industry to the subject of a presidential press conference and hundreds of news stories wondering if its collapse is a sign of a banking crisis. By Monday, the FDIC had shuttered a second bank, Signature Bank, as well. Malcolm Wardlaw, a University of Georgia assistant professor of finance in the Terry College of Business, doesn’t think Silicon Valley Bank and Signature will be the last banks to close this year — but we are far from the economic emergency the U.S. banking system saw in 2008.

Despite regulations in place after the 2008 banking collapse, there are still vulnerabilities in the system, and Silicon Valley Bank fell victim to a fairly conventional, old-school bank run, he said. Wardlaw, who studies institutional capital and corporate finance, offers answers to those not steeped in the financial world.

1. Was Silicon Valley Bank a traditional bank? Did it offer lending or banking services you can’t get at Bank of America or Synovus?

Unlike Lehman Brothers, Silicon Valley Bank was a traditional commercial bank with a standard state bank charter. It took in deposits that were FDIC insured under the $250,000 cap, made commercial loans, and had standard investments in marketable, government-backed securities.

What made Silicon Valley Bank different is it was willing to do due diligence on and lend to startup companies. The services it offered were fairly standard: working capital loans, payroll services, cash management, etc.

2. What niche services did it provide to startups and venture capitalists?

The kinds of services generally weren’t very exotic. Their service niche tended to be a willingness to handle unusual clients. Tech startups and venture capitalists have unusual business profiles. They grow very fast and tend to have larger capital and payroll needs than other early-stage businesses. They also often don’t have a lot of hard physical assets to pledge against.

Silicon Valley Bank’s niche was largely an organizational willingness to perform due diligence on these companies, whereas other banks would say: “No, this is too weird, and it doesn’t fit into our models. Come back when you’re bigger, or your needs are smaller.”

3. The bank run started after the bank sold off bonds at a loss. Why do banks hold assets in bonds?

The reason banks store money in government or government-backed bonds is they don’t carry a default risk and tend to be fairly liquid. Silicon Valley Bank had an enormous influx of deposits in 2021 when the government poured money into the economy. The increase in deposits was substantially larger than the increase in lending opportunities, so they had to put the cash somewhere.

For reasons that are still somewhat poorly understood, the bank decided to make an unusually large investment in very long-term treasuries and mortgage-backed securities with maturities over 10 years. These were simple, federally guaranteed mortgage-backed securities, so for all practical purposes, they act as default-free, long-maturity treasury bonds.

4. How do bonds lose value when the Federal Reserve raises interest rates?

This aspect of bond markets is unfortunately somewhat poorly understood by much of the public. Let’s say you purchase a treasury bond for $100 that matures in 10 years and pays 5% a year. If you hold it for 10 years, you will definitely get $5 every year plus your money back at the end of 10 years.

However, if prevailing interest rates suddenly rise to 10%, that doesn’t change anything about the cash payout to you, but it does change what someone else is willing to pay for the bond right now. The buyer can make 10% elsewhere, so they need to make 10% on what they buy from you. Since your bond still pays $5/year, the only way they can make that 10% per year is by paying you way less than $100. Thus the bond has lost value.

In some sense, you bear this loss even if you hold the bond to maturity. If interest rates stay high for the next 10 years, you’re still getting 5% but missing out on 10%. For commercial banks, this problem is actually tangible. They have to pay floating rate interest on deposits to make depositors willing to keep money with the bank. If they pay this higher rate to depositors, they make a net loss each year on the investment every year. If they refuse to pay a higher rate, the depositors take out their money, and the bank has to sell the bonds at a loss right now.

5. Are many banks facing these bond losses right now

Yup. A lot of banks have bond investments classified as “held to maturity,” so they are not marked to market. The decline in value doesn’t show up on their income statements. The complaints about this are a bit strange given that mark-to-market accounting has historically been held up as a villain over the past 20 years. You can’t have it both ways.

That said, it is not difficult to infer these losses from financial statement disclosures, so the market analysts who are paying attention definitely know it’s a problem.

6. I thought Dodd-Frank separated banks’ investment and commercial lending operations. Does bond buying count as investing? Why not?

This is occasionally a source of confusion. Commercial banks have always been allowed to invest in things such as government bonds. Historically, a number of savings banks made few commercial loans and primarily acted as a conduit for small depositors’ investment in long-run treasuries.

7. I thought we had bank stress tests now to ensure smaller banks had enough assets to cover their deposits. What went wrong here?

There is a lot of speculation at this point, much of which may or may not be true. Silicon Valley Bank, as of its last annual report, didn’t appear to be running afoul of any risk-based capital requirements. The unrealized losses on long-term treasuries were known, but it wasn’t obvious that they constituted a major risk under the existing guidelines.

8. Which parts of bank regulations were rolled back since Dodd-Frank was implemented? Did those rollbacks contribute to this failure?

There is some speculation the weaker compliance regulations for banks under $250 billion — Silicon Valley Bank was about $210 billion — may have contributed to a lack of scrutiny. The primary complaint is this threshold was raised from $50 billion by the Trump administration in 2018. However, it’s worth stating it’s not entirely clear that being subject to those tighter requirements would have averted the failure.

What is probably more salient is banks above the $250 million threshold are required to submit what are often called “death plans” or “living wills” — a set of prepackaged plans that clarify how a bank will be cleanly resolved in the event of a failure. It’s important to remember that it’s not bankruptcy which constitutes the real problem, but mass disruption in the aftermath of a bankruptcy. A “living will” would have laid a clear plan for settling the other debt and equity claims and creating procedures for how the depositors could be made whole in the event of Silicon Valley Bank’s failure.

9. What role did community panic play in this collapse? Were the depositors right to scramble to pull their money out?

This is an under-appreciated aspect of the run and how quickly it developed. The raw number of depositors in Silicon Valley Bank was fairly small, and a lot of the customers knew each other through informal channels in the startup and venture capital world. The run on the bank apparently exploded after a few high-profile public meetings and open online discussions in the Silicon Valley business ecosystem.

10. How is this different than the bank failures during the 2008 meltdown?

On the plus side, Silicon Valley Bank isn’t Lehman Brothers. As a mid-size commercial bank, it is far less complicated and easier to resolve than a massive investment bank like Lehman. Contagion is likely therefore much more limited. On the negative side, inflation pressures were non-existent in 2008, so the federal reserve had a lot more room to run in terms of pouring money into the system to ensure liquidity.

On balance, this particular episode reminds me more of the massive bank failures in Texas during my youth in the late 1980s than the 2008 meltdown.

11. FDIC Insurance only covers consumer and commercial up to $250,000, but it came out Silicon Valley Bank depositors will receive their full deposits. How is that going to be accomplished?

It’s complicated. Bank regulators have a variety of special powers which can be triggered in an emergency.

The quick public declaration over the weekend that all depositors would be made whole was possible because the agencies have these special powers. First and foremost, the FDIC and the other affiliated regulators have always had the power to sell the bank’s assets and pay out the uninsured depositors from the proceeds. This usually takes the form of a purchase by another bank that simply assumes the deposit accounts. However, the value of the assets may not be enough to make the depositors whole, and the FDIC is only bound to make up any shortfall if the deposit is insured.

The recent action assures the uninsured depositors they will be paid in full. The FDIC doesn’t yet know how big the shortfall will be, and it could in fact turn out to be zero. What regulators have said is any shortfall which is paid to uninsured depositors out of the FDIC insurance fund will need to be made up by what are effectively higher premiums paid by all FDIC-insured banks going forward.

11. Do you think we will see more banks fail?

Since the government came out with an emergency backstop on all core deposits, I don’t think we will see the same old-school, 1930s-style bank runs as we did at Silicon Valley Bank. That said, I think several banks are probably significantly underwater because of similar long-term bond investments, and there will be, at the very least, a certain amount of reorganization, if not outright failures.