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  • Writer's pictureNicholas Pihl

What's Happening at Silicon Valley Bank?

Last week, Silicon Valley Bank collapsed and was taken over by the FDIC. The short version is that they didn't have enough capital on hand to redeem all their depositors, and a bank run ensued as many of its depositors weren't covered by FDIC insurance. As for why this happened, and for a little more insight on whether it affects you and your finances, read on. Though the short version is that unless you held more than $250,000 in cash there, it probably doesn't affect you.

The bank's failure came after an amazing 10 years for the stock and the underlying business. At the start of 2013 it traded around $60/sh, rose to $740ish by the end of 2021, and then bit the dust. Until recently, this chart would have been the envy of any bank, particularly in the low-interest-rate environment of the past decade.

Silicon Valley Bank (SVB) mainly serves (well, served) startups, particularly those that have received venture capital. This makes them different from most other banks because their typical depositor is a business, rather than a person.

Why does this matter?

Part of the reason why the last 10 years were so strong is that the bank was riding the venture capital wave. As money flowed into Silicon Valley venture investments, the bank grew rapidly. Unfortunately, that exposure became a double-edged sword when many of those companies withdrew their deposits all at once.

The business model of a bank is to collect deposits and lend that money back out. Specifically, they borrow money at lower rates and lend it out at higher rates, pocketing the difference. Think about that for a minute. If you're using other people's money to make loans, do you want the type of customers who will abruptly ask for all their money back? No!

As a rule, business accounts are not nearly as "sticky" as retail accounts. Businesses move money around all the time for basic operations, whether funding major projects, or paying employees. Their accounts are overseen by aggressive and financially savvy people, who will sometimes use these accounts as a bargaining chip for securing financing, or even just to get a better interest rate. Money in these accounts moves around a lot.

By contrast, think about your own checking and savings accounts. When is the last time you changed banks? How soon do you want to do it again? For most people, it would take LOT for them to go through that process again. Even if another bank was offering more to its customers, the difference in service has to be well worth the pain and hassle of switching.

In addition, most people keep a more or less constant balance in their bank accounts, which also makes them ideal customers. Here too, SVB's average customer (venture-backed startups) was risky, because these companies routinely raise millions of dollars of financing, and spend it as aggressively as possible to deliver on their promises to investors. They raise and then spend down a massive pile of cash.

Normally that's not a problem. At least not when you have hundreds of client companies raising money at different times so that the average cash pile is relatively constant or growing. But when financing for all your customers slows down all at once, that's a problem. Now your deposits are shrinking, instead of climbing steadily higher.

As if that weren't precarious enough, the second problem for SVB had to do with the size of their customer's accounts. Most people like you or me fall well within the FDIC-insured deposit limits ($250,000 per person, per account type). So for us, even if our bank failed, we'd get our money back from the FDIC. It'd be an inconvenience, but not much more than that.

However, for SVB's business customers, $250,000 isn't all that much. These are start-ups that raised tens of millions of equity capital and are spending hundreds of thousands of dollars a month. Payroll alone exceeds $250,000. If you have $10 million parked at a bank, and that money isn't protected by the FDIC, you risk losing that money if the bank fails.

Consequently, when word got out that SVB didn't have enough money to pay back everyone's deposits, many companies pulled their money out in a matter of hours. This started a vicious cycle, where less and less money remained to pay back depositors.

That's why we're here today, 90 years after the creation of the FDIC, hearing about bank runs.

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