Bank Failure

March 12, 2023

5:57 PM PDT

Olympia, WA

Silicon Valley bank, the 16th largest bank in the US, failed on Friday. Silicon Valley Bank was unique in that its depositors were largely corporate and venture capital based. This has been a shock as this was the first notable bank failure since the wake of the Great Financial Crisis in 2008. The failure stemmed from a bank run as depositors withdrew funds in excess of the bank’s short-term liquidity buffer. There are rumors that are swirling about what actually caused the bank run, but the most plausible theories I have seen suggest that it began merely from depositors moving the funds to where they could get a higher yield as bank deposit rates have been far below short-term market rates. As these initial withdrawals took place, other depositors began to suspect there were issues at the bank and withdrawals accelerated. What is interesting about the failure is that it was not due to overleveraging or credit issues. Silicon Valley Bank had put the depositors’ funds into treasury bonds and agency mortgage-backed securities – holdings that are backed by the US government and have essentially no credit risk. The failure came from duration losses. What that means is that as the Federal Reserve hiked rates last year, that caused fixed income securities to lose value. The longer it is until a security matures, the more value is lost when rates rise. If you hold a fixed income security to maturity, assuming there is no default, you will get your money back plus yield earned. It’s only if you want to sell it before maturity that a loss is recognized. Typically, banks hedge this duration risk, but Silicon Valley didn’t take any steps to guard against that risk. This is what made Silicon Valley Bank unable to cover their withdrawals and forced selling made them realize unrealized losses. If they could have held their balance sheet to maturity, they would have been fine, but the withdrawals forced them to sell off their holdings at a loss, which brought their total assets to less than what was demanded and expected to be demanded by depositors, making them insolvent.


It looks like the dust is starting to settle and the ramifications of the Silicon Valley Bank collapse have mostly been decided. The US Treasury and Federal Reserve announced that depositors will be made whole. Investors in Silicon Valley Bank will bear large losses as Silicon Valley Bank is either acquired by a larger bank or restructured as a new bank, but everyone who had their money at the bank should be fine. This announcement was fairly surprising to me as I expected depositors with amounts above the FDIC limit to be at risk, but the US government decided that stemming any systemic risks of further bank runs takes priority.


Despite the outcome being favorable for depositors, the Silicon Valley Bank collapse is a lesson to us all that any money held at a bank is not really your money, but rather a claim on the bank’s balance sheet. Silicon Valley Bank was unique in that the majority of their client base were business depositors above the FDIC limit. This made those depositors more antsy as they would be at risk vs depositors that are fully insured with amounts in the bank below $250k. Silicon Valley Bank also had poor balance sheet risk management, failing to hedge their duration risk. Regardless, it would be wise to ensure that you do not have more than $250k in cash at any single bank in case this happens to your bank and depositors are not made whole. The economy is still digesting the Fed’s rate hikes, so it is always a possibility that this same situation happens at other banks. As I wrote about previously, there are safer places to keep your cash that also pay you a higher interest rate than at a bank account, so why take the risk? There are several good options for where you can park your cash safely, but right now I like floating rate treasuries the most in this environment.

It's also worth mentioning that brokerage assets don’t fall into the same class as cash held in a bank account. A stock that you hold in a brokerage account, for example, is not actually held by the broker. The broker could be better thought of as a record keeper. When you purchase a stock or other security, it is recorded by the broker, the clearinghouse, and the organization listing the security that you are the owner of x number of shares. If your broker collapses similar to Silicon Valley Bank, your investment securities are safe assuming that the broker wasn’t committing fraud and falsifying your trades. Your cash that’s sitting in the brokerage account, on the other hand, might fall under the same rules as a bank, so it would be wise to not have more than $250k just sitting in a brokerage account uninvested.

Investment Implications

Compared to other large banks, Silicon Valley Bank had the worst balance sheet risk management. A report by JPMorgan showed that Silicon Valley Bank was the highest risk bank of all the other banks they compared it against (Silicon Valley bank denoted as SIVB). Comparing their balance sheet to other banks, they had the highest risk deposit base and were the most exposed to duration risk by a large margin, resulting in large unrealized balance sheet losses.

This is not 2008, but it is 2023. Silicon Valley Bank was a somewhat unique situation, so I don’t think we’ll see a systemic banking event like we experienced in 2008, but it is evident that the financial system is being stressed. When the system is stressed, it doesn’t mean something has to break, but it does make it more likely to occur. It continues to look like an environment where being defensively positioned is warranted.

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