March 2023
 

The financial institution best known for its relationships with high-flying tech startups and venture capital firms, Silicon Valley Bank, experienced one of the oldest problems in banking — a bank run — which led to its failure on Friday, March 10, 2023.

Some startups that had ties to the bank scrambled to pay their workers, and feared they might have to pause projects or lay off employees until they could access their funds.

Silicon Valley Bank was hit hard by the downturn in technology stocks over the past year as well as the U.S. Federal Reserve's aggressive plan to increase interest rates to combat inflation.

The bank bought billions of dollars worth of bonds over the past couple of years, using customers' deposits as a typical bank would normally operate. These investments are typically safe, but the value of those investments fell because they paid lower interest rates than what a comparable bond would pay if issued in today's higher interest rate environment. Typically that's not an issue, because banks hold onto those for a long time — unless they have to sell them in an emergency.

 

Silicon Valley's customers were largely startups and other tech-centric companies that started needing cash more over the past year. Venture capital funding was drying up, companies were not able to get additional rounds of funding for unprofitable businesses, and therefore had to tap their existing funds — often deposited with Silicon Valley Bank, which sat in the centre of the tech startup universe.

So Silicon Valley customers started withdrawing their deposits. Initially that wasn't a huge issue, but the withdrawals started requiring the bank to start selling its own assets to meet customer withdrawal requests. Because Silicon Valley customers were largely businesses and the wealthy, they likely were more fearful of a bank failure since their deposits were over $250,000 US, which is the U.S. government-imposed limit on deposit insurance.

That required selling typically safe bonds at a loss, and those losses added up to the point that Silicon Valley Bank became effectively insolvent. The bank tried to raise additional capital through outside investors, but was unable to find them.

The fancy tech-focused bank was brought down by the oldest issue in banking — a run on the bank. Bank regulators had to seize Silicon Valley Bank's assets to protect the assets and deposits remaining at the bank.

 

At the moment experts don't expect there to be any issues spreading to the broader banking sector. Silicon Valley Bank was large but had a unique existence by servicing nearly exclusively the technology world and VC-backed companies. It did a lot of work with the particular part of the economy that was hit hard in the past year. Other banks are far more diversified across multiple industries, customer bases and geographies. The most recent round of "stress tests" by the Federal Reserve of the largest banks and financial institutions showed that all of them would survive a deep recession and a significant drop in unemployment.

 

In terms of equity markets, this has resulted in the following:

 

1. The market has concluded that the Fed will not hike next week and is questioning whether they will be forced to cut.

2. On the domestic side, the market has swung from expecting the Bank of Canada to hike later this year to now anticipating cuts.

3. The probability of other central banks hiking has also dropped.  Last week the odds the ECB would hike was set at 100%, today it is 50/50.