Academics at Bayes Business School (formerly Cass) have their say on the collapse of Silicon Valley Bank (SVB) and the subsequent actions of HSBC to save its UK arm.
On Friday 10 March, Silicon Valley Bank – one of the biggest in the US and a specialist in technology company lending – was shut down by California regulators because of concerns over its balance sheets. This marked the biggest banking collapse since the 2008 global financial crisis and the fall of Washington Mutual.
As a result, SVB’s UK arm was put in peril, as well as the more than 3,000 startup businesses who deposited their money with the bank. However, HSBC stepped in to buy SVB UK and ensure the UK enterprises would not go bust and could access money as normal. The £1 deal was struck following a night of talks with the UK government and the Bank of England.
How did it happen?
Professor Andre Spicer, Dean at Bayes and Professor of Organisational Behaviour, tells the tale of the collapse of the US arm began with an excess of money and the possibility of getting ‘bang for your buck’.
Chapter One: The Land of Milk and Honey
“Low interest rates meant there was plenty of money sloshing around the world's financial sector looking for a high rate of return. Much of this found its way to tech venture funds. They invested this money in tech companies and these companies deposited this cash into SVB.”
Chapter Two: The Fateful Decision
“Leaders at SVB decided to take a risk in search of a slightly higher return by putting many of these deposits into longer term government bonds which had a slightly higher pay-off.”
Chapter Three: The Key Turn of Events
“As interest rates began to rise, it was clear the decision to take higher risk for reward was wrong. SVB’s leadership tried to find a way out by accepting a loss and seeking new investors…but they could not.”
Chapter Four: The Fall
“News of the Bank's perilous position spread in the tight-knit tech sector and $42 billion in deposits flowed out of the bank in one day. By Friday, SVB had shuttered its doors.”
Professor Spicer says the fifth instalment remains an unknown, and although the likelihood of a repeat crisis of 15 years ago seems unlikely, the future of a profitable period in investment in private tech firms is uncertain.
“As the Federal Reserve has stepped in, the fifth part of the story is unlikely to be a repeat of 2008 as one failure ripples around the global financial system. Other banks which had close links with SVB are more likely to be affected. The big question is whether this marks the end of the long tech boom we have been witnessing.”
What were the key failures?
Dr Paulina Roszkowska is a Research Fellow at Bayes’ Mergers & Acquisitions Research Centre (MARC). She lists failures to include: insufficient regulatory oversight, risk mismanagement, a reliance that long-term interest rates will be low, or the intellectual laziness not to envision scenarios when they would have to sell “safe” securities with a loss immediately to cover liquidity needs.
But she said the biggest concern remains the risk of concentration, a risk also highlighted by colleagues.
The concentration of clients
“People are speculating as to whether the tech sector will suffer in the long term. It probably won’t be that much because venture capitalists (VCs) will provide their portfolio companies with short-term aid in the hope that they will be able to recover most of their money long-term. But as a customer, one should worry if your financial services provider is not diversified.”
The concentration of power in the hands of top tier VCs
“The actions of VCs led to fear and panic. Their calls to their portfolio companies to immediately withdraw funds from SVB led to a bank run – this is not a new thing! As a result, we have mass retail customers acting in fear, heading to the banks to pull out their savings, which amount to billions of dollars withdrawn one day. However, this has not been done by masses, but by an average of 50 portfolio companies of two dozen VCs wanting their millions out of SVB. So, if we are scared about the bank runs caused by millions of individuals, now we should be mindful that we can have the very same effect when only several powerful individuals, like those leading Silicon Valley VCs funds, decide they want their money back.”
The concentration of the banking industry post-SVB
“HSBC’s acquisition of the UK arm of SVB suddenly gives them amazing exposure to the tech sector. This is only the tip of an iceberg of more concentration in the sector because people lack trust in smaller banks. If using the 16th largest bank in the US is not enough to make you feel safe, companies and individuals will be ever more prone to only do business with the key players in the space. And as in any oligopoly, the prices and fees will follow…”
Could it have been prevented?
ManMohan Sodhi is a Professor of Operations and Supply Chain Management at Bayes. He believes there were failings in the run-up to last Friday that could have prevented the collapse.
“Two risk modelling issues were not recognised by SVB risk managers or regulators. These are: (1) assets and liabilities must be managed under risk, particularly that of interest-rate changes, and (2) the problem of correlation must be recognised, which for SVB was that their depositors – funded by a small number of venture capitalists who were also well connected with each other – could withdraw funds at the same time.
“Any bank holds its deposits in loans and fixed-income assets in various categories, which are sensitive to interest rates. The treasurer must carefully and regularly select the asset portfolio against expected withdrawals by depositors under lots of different interest-rate scenarios.
“SVB had invested in long-term bonds, not having been able to give out loans during the pandemic. When interest rates increased in the US, the values of these securities tanked, meaning SVB exceeded the value of their assets in the coming months. It appears that SVB risk managers did not consider such interest rate scenarios.
“Nor did they consider the correlation risk until the VCs asked the tech companies to withdraw their money from SVB – causing an old-fashioned bank run.”
Meziane Lasfer is a Professor in Finance at Bayes. He agrees with Professor Sodhi on the modelling failures, adding that while long-term bonds provided short-term profits for managers, the “moral hazards” of this risk-taking resulted in the CEO apparently compensated last year with $9.9 million.
Professor Lasfer, who condemned “weak supervision, risky management and managerial self-interest” at SVB, said that a lack of regulation was also a reason SVB’s fall came to pass.
“SVB was exempt from stringent bank regulations in 2018 because it was considered ‘small’. After the aftermath of the 2008 financial crisis, there was the Dodd-Frank Act to ensure that big banks will not fail and result in government bailout. However, in 2018, the regulation was lessened and allowed financial institutions to load up on risk.”
The future of the finance? Mortgage Back Bonds and Treasuries Bonds
Dr Naaguesh Appadu is a Senior Research Fellow at Bayes and believes the drama of the weekend is likely to see regulators step in to ensure the long-term protection of banks and their assets.
“People are really worried about the savings they have in the bank and will be rushing towards the bank to remove their funds due to this crisis. This will affect the banks who put all their eggs in one basket, such as SVB and Signature Bank. Other banks, which are well diversified, will not be significantly affected. There is always a high risk when it comes to startups due to lack of resources, they could have an abrupt shock, and this is the case of SVB.
“I expect regulators to react instantly to avoid such a dramatic fall in the future. One thing to watch out for is the potential stabilisation of the interest rate in the short and medium term, and it is likely that investors will prefer to deposit their funds in more stable banks from now on.”
Dr Sotiris Staikouras is a Senior Lecturer in Finance. He labelled this situation as “a special case” because of the size of the corporate accounts that SVB worked with.
Crucially, Dr Staikouras said the bank placing almost half of its investment in Mortgage Back Bonds (MBB) and Treasuries Bonds (T-bonds) impacts sell-on value.
“This is where it becomes tricky for SVB. It becomes difficult to sell the MBBs to other astute investors, and the value of T-bonds is lowered significantly as interest rates are going up. I would be disappointed if we don't see a measure introduced on how to help banks avoid having to sell their T-bonds, which would alleviate part of the problem.
“We won’t see a repeat of the credit crunch as the rest of the banking system is fairly sealed,” he added. “The UK banking system is solid and there is enough liquidity. My question would be over whether small banks may have temporary liquidity problems and depositors might act irrationally creating a bank run. This is not close to happening for now and if it happens it would be of a small magnitude.”