Last Friday, Silicon Valley Bank (SVB) collapsed after a run on deposits dashed hopes that the bank might be able to raise fresh capital. The Federal Deposit Insurance Corp (FDIC) officially took control via a new entity called the Deposit Insurance National Bank of Santa Clara. This was the second-largest bank failure in U.S. history, and the largest since the collapse of Washington Mutual in 2008.

With comparisons to a bank failure in the era of the Great Financial Crisis, it is impossible not to wonder whether the current crisis at Silicon Valley Bank is the beginning of a repeat of 2008. However, we do not believe that we are entering another Great Financial Crisis. The problems at SVB are a repeat of banking crises that have occurred many times in the past, in particular, the Saving and Loan crisis in the 1980’s. This type of problem is rooted in the business model of banks. Banks typically take in deposits and (even today after rapid Federal Reserve interest rate hikes) pay very little on those balances. On a bank’s balance sheet, deposits are shown as liabilities. Those liabilities are available to be withdrawn by the depositor (essentially, a lender of funds to the bank) anytime, without limitation. We call those checking accounts. Bankers call them Demand Deposit Accounts (DDA’s). Banks make money by lending the funds they borrow from their depositors to individuals, businesses, and other entities, most often with some asset pledged as collateral for security.

This simplified business model has a singular inherent risk: the duration of the bank’s assets (i.e.  the loans it makes to customers) is not matched to the duration of their liabilities (the funds depositors leave with the bank). Deposits can be withdrawn anytime, so the maturity of a bank’s deposit liabilities is effectively one day. The loans a bank makes usually have a variety of terms, allowing the borrower(s) to repay over one or multiple years. In the case of SVB, approximately $100 billion of their assets were invested in long duration securities such as government bonds, corporate loans, mortgages. Some of these loans are committed for multiple years.

Current banking regulations allow banks to classify a portion of these long duration investments as Held to Maturity (HTM). HTM assets fluctuate in value, but the bank does not need to mark to market the fluctuating values of the HTM assets. Assets that are not held for the long term are considered Available For Sale (AFS). AFS assets are required to be marked to market. In SVB’s case, as venture-capital fundraising dried up and clients ran down their deposits, the bank needed liquidity. To meet depositor’s requests for funds during the first quarter of 2023, SVB had to sell $21 billion of AFS assets. Because of the rapid rise in interest rates over the last 12 months, the values of these assets (loans, notes and bonds) had declined nearly 10%. The sale of the $21 billion worth of assets produced losses for the bank of $1.8 billion.

Many of SVB’s customers are, as its name suggests, Silicon Valley-based venture capital backed start-up companies and venture capital firms. News travels fast among this group, and the announcement of this very large loss created a panic among SVB’s somewhat homogenous and closely-connected depositors. Several high-profile venture capital firms, including Peter Thiel’s Founders Fund, advised portfolio companies to pull money from SVB on Thursday. SVB was overwhelmed with withdrawal requests as individuals and businesses rushed to pull out their funds. This was the modern-day equivalent of the bank run depicted in “It’s a Wonderful Life.”

This is the first tangible example of “something breaking” following the Federal Reserve’s rapid interest rate hike cycle. While it is not a foregone conclusion that contagion will spread, it is a reminder that this current cycle of monetary policy tightening has no real historical precedence and could lead to more disruption.

We recommend that clients maintain liquidity in more than one financial institution and keep bank deposits at no more than $250,000, which is the FDIC insurance limit. Keep in mind that the FDIC insurance applies to bank deposits, not investments.

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