What Could SVB Have Done Differently?

There has been considerable discussion surrounding Silicon Valley Bank since its sudden implosion. Prior to its collapse, SVB stood as one of the largest regional banks, specializing in a unique business niche – their clients primarily comprised venture capital firms and technology startups. They had successfully established strong relationships with the Silicon Valley startups and became the “go-to” bank for these burgeoning entrepreneurs. Unfortunately, their strength was also their vulnerability. In a volatile environment, their distinctive business model, coupled with mismanagement of risks, led to a sudden and massive bank run that ultimately caused the collapse of this once trusted financial institution.

Reflecting on these events, I propose the three following advice that could have helped SVB avoid the sudden implosion:

• Establish proper risk protocols to hedge duration risks,
• Improve communication strategies to mitigate the risks of bank runs,
• Diversify business model to enhance resilience.

Duration risks were one of the underlying factors that fatally contributed to SVB’s collapse. In pursuit of combating inflation, the Fed increased rates eleven times since March 2022 and. The Fed rate hikes inversely affected the present value of bond prices. As interest rates went up, the market prices of the future cash flows from fixed income securities decreased. SVB mismatched its deposits with loans and heavily invested in long-term government bonds.

By the end of 2022, SVB had a total asset value of $211 billion and held $117 billion of securities, constituting the single largest portion of its portfolio. Unfortunately, the rate hikes decreased the market price of the bonds and resulted in $15.9 billion unrealized losses for SVB’s Hold-To-Maturity (HTM) securities.

Unrealized losses would not materialize if the bank could hold these securities until maturity, ensuring the receipt of the entire cash flows. Unfortunately, a bank run occurred. From the perspective of economics, bank runs are a classic example of prisoner’s dilemma. If depositors refrain from panic, keep their money at the bank and withdraw as planned, no one need worry about accessing their deposits. However, in times of panic, depositors might fear that if others withdraw their money and they do not, they may face difficulties receiving their deposits. If most depositors seek to take out their funds simultaneously, then the result is a scenario where the majority are unable to access their deposits. This is what exactly happened to SVB.

When depositors became aware that the bank fell short on capital, panic ensued, rapidly spreading through social media. Depositors started withdrawing their deposits in waves. SVB did not have sufficient reserves to meet the surge in withdrawals and had to liquidate these HTM securities at significant losses. This directly led to insolvency of SVB.

As opposed to consumer banking, which mainly serves individual checking and savings accounts, the majority of SVB’s clients were corporations. They used the accounts at SVB for the purpose of payroll, typically involving much larger deposits held in their accounts compared to other individual checking and savings accounts. Banking is a relationship business. This specialization expedited the growth of SVB, but in times of uncertainty, it became a contributing factor to its bank failure.

The Federal Deposit Insurance Corporation (FDIC) only insures deposits up to $250,000. For amounts exceeding the insured limit, there is no guarantee that depositors would be entitled to their money. Under most circumstances, retail depositors usually do not have to worry about exceeding the insured limit. However, this guaranteed amount is easily exceeded in accounts that are used for payroll purposes, as is the case for the majority of SVB’s clients. Before the FDIC stepped in, the fear of not having access to their money exacerbated the bank run due to the nature of SVB’s business model.

Some may think that SVB’s failure was merely a misfortunate case that occurred during a bad timing – a period of uncertainty with high probability of recession, the Fed was raising rates, and the bank was simply unable to prevent depositors from withdrawing their money. Could SVB’s bank failure have been possibly avoided? The answer is possible.

Duration risks were detrimental to SVB’s collapse. Although these risks can be hedged using derivatives, SVB failed to do so effectively. The bank could have used interest rate SWAPs, options, and so forth to mitigate duration risks. But insufficient hedging, coupled with overly optimistic risk assumptions led to very relaxed risk management. For instance, the bank operated without a Chief Risk Manager for eight months prior to the failure.

Furthermore, SVB could have done more to ensure client confidence before and during the bank run. Despite excelling in client relationship developments, the bank failed to communicate sufficiently before and during the crisis, neglecting client confidence, a crucial aspect of banking’s relationship-based business nature.

Additionally, SVB could have diversified its business model to enhance resilience. While SVB’s business strategy, targeting VCs and technology startups, accelerated the bank’s growth, it also left the bank with little resilience to a crisis. This was proven during the bank run. The advice proposed here would have helped the bank bolster its defense against risks.