Why do good banks fail? The tale of Silicon Valley Bank.
Last week, a little-known Californian bank (well, outside of tech circles, anyway) hit global headlines when it collapsed.
Silicon Valley Bank (SVB) was the go-to bank for many of the US’ most innovative startups and counted companies like Roku, Etsy, and Roblox as customers. On 10th March, it was announced that SVB had been closed by the California regulators and taken over by the FDIC, a federal institution that steps in when banks fail.
So, what happened exactly? Can banks really just spontaneously implode and how can this impact VC-backed companies, bootstrapped startups, and designers?
Why and how banks can collapse
SVB isn’t the only bank to experience a dramatic fall recently. Silvergate and Signature Bank (which are well-known in the crypto space) have also crashed in the last month. While these banks are of varying sizes and they all serve a different clientele, they all fell for the same reason. That’s because of something called a ‘bank run’.
And no, it has nothing to do with running.
This is when many people try to withdraw their money at the same time, usually due to challenging financial conditions. The banks don’t have the cash on hand to service these withdrawals, and that spells serious trouble.
The reason bank runs are possible is due to fractional reserve banking. Some people say this is the root of all evil. And some people say it's the birth of capitalism. But what does it mean?
It simply means that your bank does not need to have ‘all the money in cash’ all the time. So, if you have a savings account with $10,000, a bank can take (for example) $9,000 and invest it further. Of course, there are strict guidelines around what they can invest in. Mostly very safe stuff, like bonds.
But this means that if everyone came to a bank today and demanded their $10,000, the bank couldn't give it to them. It would go bankrupt. Without doing anything against the rules.
Why this happened to SVB
The case of SVB is particularly interesting because it’s a bit of a ‘chicken or the egg’ situation.
Bank runs often occur because customers believe the bank will fail, leading many of them to pull out their money within a short window. The question with SVB is: was this a self-fulfilling prophecy, or did the depositors have inside knowledge of the financial state of the bank?
In early March, rumors began swirling that SVB is holding a significant amount of investments (bonds, securities) that are losing value dramatically. This is called unrealized losses and puts the bank at risk of a credit downgrade. In an attempt to cap the downside and clean up its balance sheet from these bad-performing investments, SVB sold $21 billion of its portfolio at a $1.8 billion loss.
Panic ensued, and many hedge funds and venture investors rushed to withdraw their funds so they could pay their creditors. At this point, the California Department of Financial Protection and Innovation was forced to step in and shut the bank down.
This fiasco could have a catastrophic impact on not only the startup landscape but also the US and even the global economy.
When one bank run happens, customers of other banks may feel their money isn’t safe either, which can cause another bank run. Once you have two bank runs, it can wreak absolute havoc. Imagine a widespread bank run across all banks around the globe. Let's just say, it wouldn't be pretty. Not at all.
However, luckily, not all is lost. As it turns out, SVB is covered by a systemic risk exception, meaning the bank was big enough that the US government will step in to help them. The FDIC has confirmed that 100% of all deposits are insured, which means that account holders will be able to pull out all their money. Deposits will be covered by the Deposit Insurance Fund, which is a kind of insurance fund that banks pay into for such events. And this also means that taxpayers won’t have to bear the financial brunt of the situation. Phew.
How is this relevant for designers?
While the SVB situation has been less of a crisis than anticipated, it’s enough to make anyone grateful not to be the one making financial decisions in a business! However, that doesn’t mean sticking our heads in the sand is an option. Knowledge is power — and being aware that this can happen will help prevent you from being blind-sighted in the future, should this ever happen to your organization.
If you’re working as an in-house designer: Understand the biggest risks for your business. For banks, it is bank runs. For restaurants, it may be poor hygiene. For search engines, it's AI (hey, Google 👋). Don’t be afraid to ask the hard questions of the chief decision-makers in your company, and do your own research. What has happened to other companies in your sector? And what does that mean for the way you need to design your product or service? Contingency planning is important and as designers, we need to be aware of the biggest risks to the product or services we design.
If you’re an entrepreneur or startup owner: Consider how you might be able to avoid putting all your eggs in one financial basket. Keep tabs on exactly how much you have with each institution (if you have multiple), and think about keeping a reserve of liquid cash, in the unfortunate event a situation like this ever affects your bank.