The Silicon Valley Bank (SVB) behind many start-ups sent markets panicking when it crashed recently, starting a chain of events that led to the acquisition of Credit Suisse by long-time rival UBS, and Deutsche Bank’s stock stirring.
Over in Singapore, government-linked investment firm Temasek stated that they are not directly exposed to SVB. Similarly, the Monetary Authority of Singapore said the Singapore banking system has insignificant exposures to the failed banks in the United States.
In the United States, the US Federal Deposit Insurance Corporation (FDIC) acted swiftly to recover deposits to bank customers within a week, even those above the insured amount of US$250,000 per bank account. In this case, even start-ups with large balances exposed to SVB likely will not face a large liquidity constraint.
What caused SVB to fail?
At a larger scale, what toppled SVB was an interaction of the rising interest rate environment and its massive risk appetite. Prior to the interest rate hikes in 2022, SVB had bought a large amount of mortgage-backed securities whose prices fall when interest rates rise.
However, those losses in the so-called “hold-to-maturity” assets were not explicitly recognised in its income statement. What many did not realise was that SVB’s position reflected a bet. SVB would not have realised losses if it could have held those assets to maturity and the securities themselves paid off. Confidence in the mortgage market combined with people discovering the non-booked losses on these hold-to-maturity assets sparked a run for customers to get their money out.
At a larger scale, what toppled SVB was an interaction of the rising interest rate environment and its massive risk appetite. (Stock image)
The quick and large withdrawal by existing customers who might view those hold-to-maturity losses as real losses, even when the losses were not booked, would have caused SVB to fail immediately. Once the withdrawals were larger than their existing liquidity, SVB was forced to sell the hold-to-maturity assets at a loss, realising the losses and starting the death spiral.
Not long before the crash happened, Forbes named SVB as one of America’s best banks. It was a willingness to take risks that won SVB the honour. But it was also the fuel that burned when the bank run ignited the flames.
SVB’s investment in mortgage-backed securities was a result of a dramatic surge of deposits in the zero-interest rate era. It had also made loans to start-ups, with the requirement that those start-ups deposit their loan proceeds back with SVB itself. This contributed to the surge of deposits and also resulted in companies with large balances in SVB.
But the requirement for borrowers to deposit large loan amounts back with SVB itself also led to a large share of uninsured deposits. These companies would have stood to lose substantially if the bank had indeed failed. Meanwhile, smaller retail customers are well covered under the FDIC insurance of US$250,000 and do not have as much incentive to keep a close eye on the quality of the bank’s assets.
How will SVB’s fall change the future?
In the near term, there is a much lower sentiment in Singapore now for growth stocks, such as those from new start-ups with minimal cash flows. A case can be made that this is a rightful and inevitable correction. The public markets had a rough 2022, and private market assets like venture capital and private equity still have not started recognising losses due to delays in financial reporting.
In the longer term, start-ups would still find the US fertile ground despite SVB’s demise. This rescue operation by the government, making even bank customers with balances above the FDIC insurance amount whole, will likely cause banks to want to take even more risks. Now they know that even if they are not a “too-big-to-fail” systematically important financial institution, the government can still come to their rescue. As the risk-taking increases in the medium to long term, this means lowers costs of capital and more favourable terms for start-ups.
In the longer term, start-ups would still find the US fertile ground despite SVB’s demise.
Asst Prof Ben Charoenwong
Since the FDIC will likely recover all deposits quickly, start-up founders will feel assured about their funds. In fact, they may even want to raise more assets in America from banks willing to take big risks since they come with an implicit government guarantee.
Not much impact on start-ups but an indirect impact on market correction
Overall, I do not anticipate the fall-out to really impact early-stage startups as they recover their deposits fairly quickly.
SVB played two main roles. The first was to lend money to venture capital firms (VCs) that funded companies. This was part of a standard lending portfolio of many banks, although SVB was particularly aggressive in doing so. If VCs lost their financing ability, this would raise the cost of capital of start-ups that are prospective portfolio companies. Although this can have medium-term consequences, it would not have led to the imminent failure of start-ups.
The second role was to offer loans directly to start-ups, sometimes for some equity-like payoff and effectively playing somewhat of a VC role itself. They were also providing mortgages to the founders of those VCs. This latter line of business was much riskier and less common. To the extent that the start-ups themselves were unlikely to fail, the risks on these mortgages were also not huge. Because SVB often required start-up borrowers to deposit their loans back into SVB, the risk was that SVB’s failure would have caused these start-ups’ liquidity to disappear—affecting their going concern.
Given how SVB specialised in the pocket of start-ups in the west coast, the risk of contagion was low. The other banks recently affected, like Silvergate, Signature Bank, and Credit Suisse are in a bad situation due to other sources, namely their exposures to cryptocurrency, flaunting of anti-money launder and know-your-client regulations, and genuinely souring loans.
The fall of SVB will not change much. The short-term impact is the market correction that raises the cost of capital for start-up founders, many of whom have not seen non-zero interest rates in their careers. However, given what we saw in the markets in the past several years, the market is a long time coming and probably inevitable.
