TL;DR (it's a long article)
If you were banking with SVB, you’ll have more gray hair than you did on Wednesday last week. If you weren’t, then you got lucky. The good news is that the Feds will make sure that SVB depositors will get their cash.
The bad news is that the $250k limit on Federal Deposit Insurance seems to be more of a suggestion than a rule. Can you spell 'moral hazard'?
What does this mean for startups? My guess is that in the short term VCs are going to be even more focused on risk than they were before... which is a lot. So be ready for an even harder fight.
On the other hand, it's going to drive demand for more banking options that are customized for startups. There's an opportunity there, for sure.
SVB (Silicon Valley Bank) failed this past Friday; in just 44 short hours, we witnessed the largest bank failure in the US since 2008. News about the failure has dominated headlines the last few days and the situation is still front-and-center of the tech and venture capital world.
On the face of it, SVB’s failure seems to be the result of a ‘classic’ bank run. And to be honest there’s not much I can add to the discussion that’s ongoing even now. But, as always, I’m interested in looking deeper since there is always more to the story.
So what happened? TechCrunch summarizes the run of events (sorry) pretty well but my belief is that a little historical context is helpful: This drama has its genesis in our recent (and not so recent) history.
Not long ago, money was cheap and had been for some time. Interest rates were low – even negative in real terms – and VC money was pouring into SVB in the form of customer deposits. It wasn’t until last year that anyone realized that the VC market wasn’t going to last forever – the slowdown in venture funding was both rapid and precipitous:
But we need to go back even further than last year: In 2018, the Economic Growth, Regulatory Relief and Consumer Protection Act (“EGRRCPA”) was signed into law by then-President Trump. Banks, lobbyists, and politicians had been pushing hard for this measure for years. They argued Dodd-Frank was a ‘one-size-fits-all’ solution that imposed an unreasonable burden for regional and community banks. In fact, SVB’s CEO lobbied congress for the rule changes it contained – reducing regulatory oversight on the bank.
Basically, the bill kept stress testing in place for “SIBs” – Systemically Important Banks, financial institutions with less than $250 billion in assets – but smaller banks including SVB were largely exempted from enhanced prudential standards. Forbes magazine has an excellent article on how this contributed to SVB’s failure.
As SVB’s CEO had hoped, the bank was not considered to be a SIB under the new law. At the time, it had about $40 billion in assets; even last week, SVB had just over $200 billion, keeping it under the $250 billion threshold. However, given that SVB was the primary banker for nearly 50% of VC-backed tech and life science companies in the United States, and over 2,500 VC firms, it is difficult to see how they couldn’t be considered ‘systemically important.’ Clearly, the assets test wasn’t fit for purpose.
Nonetheless, they were not required to report key capital and liquidity ratios and stress-test results that might have caught the issue earlier.
The bottom line is, once SVB’s funding activities became public information - combined with the fact that even SVB appeared to be caught off guard - some customers (and their VCs) panicked and started withdrawing cash at an alarming rate. Insider reports that customers were withdrawing deposits at a rate of $500,000 per second on Thursday, 10 March, leading to a bog-standard bank run.
So what are the takeaways?
First, this appears to be a failure of SVB’s internal risk management processes and systems. SVB clearly failed to adequately manage its asset-liability structure and held too many low-yielding assets even after it became clear that interest rates were not only going up but were likely to stay high for some time. The lesson is, risk management can actually be a matter of life-or-death importance.
Second, interest rates went up faster and further than management anticipated. Managers at SVB couldn’t control this, but it’s clear that they didn’t react fast enough to the markets. The lesson is… pay attention and be ready to act.
Third, I suspect that senior managers at SVB were confident that they could manage the situation and that their customers would remain loyal. I also believe that they were ‘blind-sighted’ by past experience: the fact is, it’s been at least a generation since startups went bust in any significant way. When VC investment started to slow, SBV’s management should have been on guard and been able to position their balance sheet to meet the headwinds they knew were coming. The lesson is, stay humble and don’t take anything for granted – especially customer (or shareholder) loyalty.
This leads us to a fourth (but certainly not final) contributor: Reduced oversight from the Fed almost certainly allowed SVB to operate under the ‘stress test radar’ for far longer than it should have. The 2018 law that eliminated stress testing and enhanced reporting created a vacuum where SVB’s asset-liability mismatch could remain hidden. Is it possible that this might have caught the problem earlier? Almost certainly. One lesson is that just because you aren’t required to do something doesn’t mean you don’t need to do it. These are two entirely different things. Nobody likes regulation or the costs associated with it, but until human nature changes in a fundamental way it will be needed.
If you were banking with SVB, you’ll have more gray hair than you did on Wednesday last week. If you weren’t, then you got lucky.
What does this mean for startups? My guess is that in the short term VCs are going to be even more focused on risk. While this is something that they should have been aware of, they clearly weren't! Early reports say that some customers signed exclusive banking contracts that didn't permit diversification. This is one way you can protect yourself: don't be exclusive with one bank.
The good news is that the Feds will make sure that SVB depositors will get their cash. That relieves pressure not just on startups and VCs, but on the LPs who provide capital to the VCs as well. That's critically important, and in my view, it's actually what drove the Fed's support.
On the other hand, it's going to drive demand for more banking options that are customized for startups. There's an opportunity there, for sure. There will also be a lot of attention to 'concentration risk'.