A founder’s perspective on SVB’s collapse

We opened our bank account with Silicon Valley Bank as soon as we incorporated the Company in April 2015. And for the past 8 years, we didn’t give it another moment’s thought. Until last Thursday. 

Last weekend was one of the longest weekends of my life.

I remarked to many friends and former colleagues that this reminded me very much of the Lehman weekend. I remember that one well – having started my career on the graduate program there just 2 months before Lehman went bust. But personally, this was much bigger. Origin has just celebrated our 8 year anniversary. Last year was our best year ever on every single metric. And now we faced the prospect of losing it all.

Of course, by now everyone knows how the story ends. We were clients of SVB UK, which has been purchased by HSBC for a symbolic £1. Our deposits are safe, and in a sense, it’s back to business as usual. 

But, in another sense, things do feel different.

Echoes of Lehman

There are plenty of bank capital experts amongst our readership who will understand more deeply than I the causes of the SVB’s trouble. But to summarize:

• SVB’s balance sheet ballooned during covid, with huge deposit inflows from monster VC funding rounds getting parked in long dated bonds at historically low rates. Banks can choose whether to hold bonds in an “available for sale” (AFS) book, and mark them to market, or in a “hold to maturity” (HTM) book, and keep them marked at cost.

• Rising interest rates affected SVB’s customers (tech companies), resulting in SVB’s deposits decreasing, while also marking down the value of SVB’s AFS and HTM bond portfolios. Interest rate risk wasn’t hedged. 

• A public announcement about the scale of the losses in the AFS portfolio caused a panic among depositors, the vast majority of whom held balances above the insured amount, causing a run on the bank. 

• In the US, the FDIC stepped in, invoked an emergency “systemic risk” clause, and backstopped all depositors, even beyond the $250k limit. In the UK, the government stepped in and forced a sale of SVB UK to HSBC.

One of many

Importantly, SVB isn’t the only bank to have a portfolio of bonds that may have lost value in the recent inflationary environment. 

A paper published this week states that the US banking system has unrealised bond losses of $2 trillion! (Unrealised because the losses are in the HTM book, not the AFS book). And J.P. Morgan’s analysts have published reports showing the size of unrealised losses are sitting on other bank’s balance sheets. 

All banks have suffered the same COVID induced conundrum. As the JP analyst states: “Between Q4 2019 and Q1 2022, deposits at US banks rose by $5.4 trillion, and due to weak loan demand, only ~15% was lent out; the rest was invested in securities or kept as cash.” 

SVB may have had the most fickle deposit base, but it’s hardly unique. Much scrutiny is rightly being placed on every other banks’ securities portfolio and the stickiness (or lack thereof) of their depositor base.

Duration mismatch 

While SVB UK looks to have been responsibly capitalised, (and could quite well have been the deal of the century for HSBC to buy it for £1), SVB US had a huge duration mismatch, and there is a lot of tension around the FDIC decision to backstop all depositors of SVB US.

Apparently European regulators are seething at their counterparts in the US, for watering down regulations for regional banks, missing red flags in SVB’s balance sheet up until now, and then setting a dangerous precedent by bailing out uninsured deposits (deposits above $250k). 

Right-wing presidential candidates in the US are pushing the narrative that guaranteeing depositors was a bailout, and that depositors should have lost their money. 

Implications

The final implications of all this are still to be seen (much as the fallout from the GFC are still being felt). 

Ultimately, we are facing an existential reckoning of our economic and social contract with the banking sector. Does this backstop of uninsured deposits create moral hazard? Is it normal to expect small business owners and entrepreneurs to conduct deep due diligence on their bank’s credit worthiness, both when opening their account, and also on an ongoing basis? 

Matt Levine sums it up nicely:

“ I think the modern bank-regulatory view is that the point of a bank deposit is that you shouldn’t have to worry about it, and that it is a failure of bank regulation if depositors of any size have “to actually give a moment’s thought to the riskiness” of a bank. (Bank deposits are meant to be “information insensitive.”) 

There are vast areas of life where we don’t worry about moral hazard. We don’t say things like “the moral hazard of food safety regulation is that we’ve greatly reduced the incentive for consumers to give a moment’s thought to the riskiness of their supermarket’s supply chain.” 

That’s not a thing you’re supposed to think about!”

An entrepreneur’s perspective 

As an entrepreneur, I can tell you that I have about 50 things I worry about every day that are life and death for our business, but the safety of our bank deposits is not one of them. And fundamentally, I don’t believe it should be.

Our world and economy will be a worse place if bank deposits were not assumed safe. Bank runs and bank failure would become more likely. Sure, for Origin’s issuer clients, experts who work at multinational organisations with billion dollar balance sheets and large, well staffed treasury departments, bank counterparty risk is one of many important risks that should be closely monitored. 

But for the vast majority of small business owners who have deposits above the insured limit but are still small businesses, worrying about your bank should not be in the top 10 or even top 50 lists of regular concerns. So, it’s quite right that the US FDIC backstopped all depositors. 

The previous paradigm of deposits being insured up to a limit was set nearly 100 years ago, way before online banking and Twitter. Last weekend showed us that bank runs can originate and propagate a lot faster in today’s world, and our regulations and safety nets need to be updated to reflect that.

But, if all bank deposits are now government guaranteed, not just those up to the insured limit, this has huge implications for the regulation and profit expectations of our banks. 

Tougher rules

Bank shareholders and bank management get leveraged returns on their asset books by virtue of guaranteed deposits. Essentially, governments are now explicitly saying that profits will be privatised, but losses will be socialised across the entire financial sector. Banking has always been a public-private partnership in a sense…but the scale of the public side is becoming a lot clearer with every passing crisis. 

This is quite rightly leading to more regulation. The US Fed is apparently considering tougher rules for mid-size banks after this week’s events (rules that were initially put in place in 2010, but then watered down in 2018). 

How this ends

It’s not obvious exactly how this ends. At the very least I expect more concentration, more regulation, lower shareholder returns to banks, and a renewed interest in non-traditional financial service providers (BTC etc). 

Lastly, it shows us that many of the ramifications of the recent bout of severe inflation and interest rate rises has yet to be seen. This tidal wave is far from over.

For those navigating the markets – stay safe and nimble.