Six Bayes Business School (formerly Cass) finance scholars discuss the collapse of the Silicon Valley Bank (SVB) and subsequent action by HSBC to save its UK branch.
Photo: Karolina Grabowski on Pexels
What happened?
On Friday, March 10, Silicon Valley Bank – one of the largest banks in the US and specializing in lending to technology companies – was shut down by California regulators over concerns about its balance sheets. This was the largest banking collapse since the 2008 global financial crisis and the fall of Washington Mutual.
This put SVB’s UK branch at risk, as well as the more than 3,000 start-up companies that had deposited their money with the bank. However, HSBC stepped in to buy SVB UK to ensure UK companies don’t go bust and have cash as usual. The £1 deal came after late night talks with the UK government and the Bank of England.
How come?
Professor Andre Spicerdean at Bayes and professor of organizational behavior, tells the story of the US bank collapse, which began with a cash surplus and an opportunity to “get great bang for your buck”:
Chapter One: The land flowing with milk and honey
“Low interest rates meant there was a lot of money floating around in the global financial sector in search of high returns. A lot of that money went into venture funds for the tech industry. They put that money into tech companies, and those companies put that money into SVB.
Chapter Two: The Fateful Decision
“The SVB leaders decided to take a risk in search of a slightly higher yield by investing a large part of these deposits in longer-dated government bonds, which carried a slightly higher yield.
Chapter 3: The decisive turn of events
“As interest rates started to rise, it became clear that the decision to take more risk for a higher return was wrong. The SVB leadership tried to find a way out by taking a loss and seeking new investors. .. but that didn’t work.”
Chapter Four: The Case
“News of the bank’s perilous position spread across the tight-knit tech industry, and in one day, $42 billion in deposits spilled out of the bank. The SVB closed its doors on Friday.”
According to Professor Spicer, the fifth chapter remains an unknown, and while the likelihood of a repeat of the crisis of 15 years ago seems unlikely, the future of a profitable period of investment in private technology companies is uncertain.
“With the Fed stepping in, it’s unlikely that part five of the story will be a repeat of 2008, as a default would wreak havoc on the global financial system. Other banks that have had close ties to the SVB are more likely to be affected The big question is whether this will spell the end of the long tech boom we’ve seen.”
What were the main failures?
Dr. Paulina Roszkowska is a research associate at the Bayes Mergers & Acquisitions Research Center (MARC). Mistakes she cites include: inadequate regulatory oversight, mismanagement of risk, trusting that long-term interest rates will be low, or intellectual laziness in not imagining scenarios in which they would have to immediately sell “safe” securities at a loss in order to to meet liquidity needs.
However, the main concern remains the concentration risk, which was also highlighted by her peers.
The customer focus
“There is speculation as to whether the tech sector will suffer in the long term. Probably not so much, as venture capitalists (VCs) will help their portfolio companies in the short term, hoping they can get most of their money back in the long term. But as a client, one should worry if their financial services provider isn’t diversified.
The concentration of power in the hands of the leading VCs
“The actions of the VCs triggered fear and panic. Their request for their portfolio companies to immediately withdraw funds from the SVB led to a bank run – this is nothing new! As a result, the mass of retail customers are going to the banks for fear of losing their savings which amount to billions of dollars withdrawn in one day. However, this time it wasn’t about masses, but an average of 50 portfolio companies of two dozen VCs looking to withdraw their millions from SVB Fearing bank runs triggered by millions of retail clients, we should now consider that if only a few powerful individuals, like Silicon Valley’s leading VC funds, decide to claw back their money, we can have exactly the same effect.”
Concentration of the banking sector after the SVB
“HSBC’s acquisition of SVB’s UK arm suddenly gives it an amazing exposure to the technology sector. This is just the tip of the iceberg of further concentration in this sector because people don’t trust smaller banks. When leveraging the 16th largest Bank in the US is not enough to feel safe, companies and individuals will increasingly tend to only do business with the major players in this space. And as in any oligopoly, prices and fees will follow…”
Could the collapse have been prevented?
Man Mohan Sodhi is Professor of Operations and Supply Chain Management at Bayes. He believes there were omissions leading up to last Friday that could have prevented the collapse.
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Two aspects of risk modeling were not recognized by SVB risk managers and regulators. These are: (1) Assets and liabilities must be managed under risk, espparticular under the risk of interest rate changes, and (2) the problem of correlation must be recognized, which for the SVB was that its depositors – funded by a small number of venture capitalists who were also well connected – were withdrawing funds at the same time could.
Each bank holds its deposits in the form of loans and fixed income assets in different categories that react to interest rates. The treasurer must carefully and regularly select the investment portfolio against expected depositor withdrawals under many different interest rate scenarios.
The SVB had invested in long-term bonds as it was unable to lend during the pandemic. As interest rates rose in the US, the values of these securities fell, causing the SVB to outperform its investments in the coming months. Apparently, the risk managers at the SVB did not take such interest rate scenarios into account.
Nor did they consider wrong-way risk until the VCs asked the tech companies to pull their money out of the SVB – triggering an old-fashioned bank run.”
Meziane Lasfer is Professor of Finance at Bayes. He agrees with Professor Sodhi on the modeling errors, adding that while long-dated bonds have provided managers with short-term gains, the “moral hazard” of that risk-taking led to the CEO apparently being compensated $9.9 million last year .
According to Professor Lasfer, who denounced the SVB’s “weak oversight, risky management and self-interest of managers”, a lack of regulation was another reason for the decline of the SVB.
“SVB was exempt from strict banking regulations in 2018 because it was considered ‘small’. After the 2008 financial crisis, the Dodd-Frank Act was enacted to ensure big banks didn’t fail and have to be bailed out by the state. However, in 2018, regulations were relaxed, allowing financial institutions to take on risks.”
The future of finance? bonds and government bonds
Dr. Naaguesh Appadu is a senior research fellow at Bayes and believes that given the dramatic events of the weekend, regulators will step in to ensure the long-term protection of banks and their assets.
“People are very worried about their savings and because of this crisis they will rush to the bank to withdraw their money. That will hit the banks that put everything on one card, like SVB and Signature Bank. Other banks, well are diversified will not be as badly affected.Start-ups are always at high risk of suffering a sudden shock from lack of resources and this is the case with the SVB.
I expect regulators to act immediately to avoid such a dramatic drop in the future. One thing to watch out for is the possible stabilization of interest rates in the short and medium term and it is likely that investors will prefer to place their funds in more stable banks from now on.”
Dr. Sotiris Staikouras is Senior Lecturer in Finance. He described this situation as a “special case” due to the size of the corporate accounts that the SVB worked with.
It is crucial, according to Dr. Staikouras that the bank places almost half of its investments in Mortgage Back Bonds (MBB) and Treasuries Bonds (T-Bonds), which affects resale value.
“This is where things get tricky for SVB. It becomes difficult to sell the MBBs to other smart investors and the value of the T-Bonds falls significantly as interest rates rise. I would be disappointed if not one A measure would be introduced to help banks avoid selling their T-Bonds, which would mitigate part of the problem.”
“We will not see a repeat of the credit crunch as the rest of the banking system is quite tight,” he added. “The UK banking system is sound and there is ample liquidity. My question would be whether small banks could experience temporary liquidity problems and depositors could act irrationally, which could lead to a bank run. This is not foreseeable at the moment and if it were to happen it would be of minor magnitude.”
