Jill On Money: Lessons from Silicon Valley Bank’s failure

Silicon Valley Bank, which catered to technology startups and the venture capital firms that financed them, was taken over by the Federal Deposit Insurance Corp. (The FDIC is an independent agency of the U.S. government that protects customers of insured banks against the loss of their deposits, up to $250,000, per depositor, if an insured bank fails.)

Silicon Valley Bank was the second-largest bank failure on record and has led many to question the stability of other, similar small to medium-size niche banks that provided funding to high growth sectors like tech and crypto.

Although the Silicon Valley Bank story is still unfolding, there are important lessons that we can learn.

Know where your deposits are

Every banking consumer should keep their money at FDIC-insured institutions, and individual account balances should remain under $250,000. The FDIC provides separate insurance coverage for different categories of legal ownership (e.g., joint or trust accounts).

The FDIC notes: “This means that a bank customer who has multiple accounts may qualify for more than $250,000 in insurance coverage if the customer’s funds are deposited in different ownership categories and the requirements for each ownership category are met.”

If you are unclear about whether your various accounts are covered by the FDIC, contact your bank to learn more. Since the FDIC began operations in 1934, no depositor has ever lost a penny of FDIC-insured deposits. Talk about peace of mind!

Reaching for higher interest rates involves more risk

As the tech sector boomed on the back of low interest rates and abundant funding, many of the companies that held accounts at Silicon Valley Bank prospered and were able to deposit a lot of money at the bank.

Silicon Valley Bank did what many banks do: It kept what it thought was an adequate amount of cash on hand to meet any withdrawal demands from its depositors and used “extra cash” to purchase U.S. Treasuries. To boost the amount of interest they earned, Silicon Valley Bank bought longer-dated bonds, which are often more price sensitive to interest-rate moves.

When interest went up, Silicon Valley Bank showed a paper loss on its bonds. Normally, that wouldn’t be a problem, but as tech and startup companies came under pressure over the past 18 months, they needed to withdraw their deposits at Silicon Valley Bank to finance their operations. To meet those depositor demands, the bank was forced to sell its government bonds prior to maturity — and at a loss — to free up money. Silicon Valley Bank management forgot a core investing concept: Higher yield can increase risk.

ZIRP hurts

For years, the Federal Reserve maintained a zero percent interest-rate policy (“ZIRP”). When rates remain low for long periods of time, it encourages growth but also can lead to outsized risk taking. Now that the Fed has reversed course and is hiking interest rates to beat back inflation, there are unintended consequences, like a bank being forced to sell its “safe” bonds at a loss to meet its obligations.

Bigger is better for banks

After the financial crisis of 2008, the government stepped up the requirements for large institutions, which forces them to keep more cash on hand than small to midsize banks. Additionally, large banks have a more diversified customer and funding base, which can shield them from such shocks.

Watered-down regulation can bite back

Silicon Valley Bank was one of the small to midsize banks that lobbied the government to ease post-financial-crisis banking regulations. In 2018, those efforts bore fruit, as the Trump administration reduced regulations and oversight for banks with assets less than $250 billion. Perhaps with more oversight and higher capital and liquidity requirements, Silicon Valley Bank may have avoided this disastrous outcome.