The banking collapse (SVB & Silvergate) — 2023

“Silvergate Bank going under is bad. Silicon Valley Bank going under would be exponentially worse. Let’s hope that doesn’t happen,” — Scott Melker

The collapse of two US banks within a span of just a few days has sent shockwaves through the financial world. The first to fall was Silvergate Capital Corp, a crypto-friendly institution whose stock had already fallen 94% over the past six months. On Wednesday of last week, Silvergate announced that it would begin voluntary liquidation to try to meet its liabilities, causing the stock to fall another 50%. Then, on Friday, Silicon Valley Bank (SVB), a commercial bank that primarily served start-up’s and tech companies in California, was shut down by the Federal Deposit Insurance Corporation (FDIC). SVB had seen its own stock drop 60% on Wednesday alone and another 66% in pre-market trading on Thursday before stock trading was halted. At the end of 2022, Silvergate had $6.3 billion in deposits, compared to SVB’s over $170 billion — 27 times what Silvergate had and roughly 17 times the amount of customer funds that were misappropriated by FTX.

SVB’s collapse is particularly problematic as it is the largest bank to collapse since the 2008 financial crisis and the second-largest bank collapse in US history. What is even more surprising is that the collapse appears to have been caused by a bank run, where customers withdraw more money than the bank has on hand, since it uses customer deposits to lend out loans and cannot immediately recall that money. This is a problem that many consider to be an old problem and one that we have not seen to this scale since the 2008 financial crisis.

While many are ringing alarm bells and warning that this could be the next big financial crisis, it is important to provide a well-rounded perspective on the situation. The problem is complex, and things could evolve very quickly, so it is incredibly early to make such a drastic call. However, there are problems here that are worth addressing.

Silvergate was an otherwise conventional financial institution that provided services for cryptocurrency companies and exchanges. A lot of their clients were cryptocurrency-focused, which was a really good niche for them prior to 2022. However, with the collapse of FTX and all the fraud surrounding the situation with Sam Bankman-Fried, it led to a run on cryptocurrency exchanges, which translated into a run on Silvergate’s assets. In the last three months of 2022 alone, Silvergate customers withdrew $8 billion of their crypto-linked deposits, which represented roughly two-thirds of the cryptocurrency deposits. Because the bank did not have the full $8 billion on hand, they had to sell $5.2 billion worth of their assets to meet this demand, which translated into a loss of $718 million. To put this loss into perspective, if you took all the money that the bank made in profits from 2016 up to the third quarter of 2022, it wouldn’t even cover a quarter of the money lost in Q4 of 2022 alone.

Looking at the bank’s balance sheet, as of December 31, 2022, their total asset size was $211,793 million, with a significant portion of that being loans given, totalling around $73,600 million. A major chunk of these loans, around 55–60%, is given to global fund banking, which is venture capital or private equity funding. However, the bank also invested heavily in securities held to maturity, which are long-term securities, such as US government bonds. This is where the problem arises. As of December 31, 2022, SVB had $91,000 million invested in securities held to maturity, which could lead to potential liquidity issues if they need to sell them in a hurry. Looking at the bank’s deposits, SVB had a significant increase in non-interest bearing demand deposits, which are like current accounts. In 2019, they had deposits of $40 million, which increased to $125 million by 2022. This increase in deposits gave SVB more funds to lend out, but it also increased their liquidity risk.

Banks hold a lot of their money in treasury bonds, including customer deposits, which is seen as a relatively safe and liquid investment. However, many of these bonds were acquired when interest rates were near rock bottom over the past decade when the federal funds rate was near zero. The fundamental relationship in bonds is that their price is inversely related to interest rates, so when interest rates were low, these bonds were purchased at a high price. Now that rates have had a very aggressive move higher, prices for these bonds on the market have decreased quite dramatically.

Bonds are still typically a safer investment because you could technically just wait for them to mature to get the face value of the bond back, so you wouldn’t necessarily realize such a drastic loss.

The situation came to a head when the bank announced a voluntary liquidation of its assets, selling everything to try and meet all of its liabilities. This followed the announcement that the company wasn’t sure if it would be a going concern business, and the fact that the bank had to take bonds that were classified as such on their balance sheet and sell them, further widening the loss.

What’s more, the company is still being investigated by the Department of Justice for its connections with FTX and Sam Bagman Freed, who were allegedly big customers at the bank with over one billion dollars of assets with them. This investigation has added to the uncertainty surrounding the bank’s future and has likely contributed to the withdrawal of large sums of money by customers.

Finally, it’s worth noting that the collapse of Silicon Valley Bank may not necessarily lead to a contagion effect throughout the US financial system. While some regional banks saw their trading activity halted, it’s important to remember that Silicon Valley Bank is just one of many financial institutions in the US, and other banks may not necessarily be exposed to the same risks.