Through its nearly four decades of existence, Silicon Valley Bank served numerous tech startups and became the largest bank by deposits in Silicon Valley. Over a period of just two days in March 2023, the bank went from solvent to broke as depositors rushed to SVB to withdraw their funds, resulting in federal regulators closing the bank for good on March 10, 2023.
SVB’s collapse marked the second largest bank failure in U.S. history after Washington Mutual’s in 2008. While bank failures aren’t uncommon, it’s rare to see banks of SVB’s size become insolvent. When these rare occurrences happen, questions arise about how they can be prevented.
In the following conversation, UW Law Professor Anita Ramasastry provides background on this matter and answers questions surrounding bank failures.
UW Law: Why have banks, such as Silicon Valley Bank, failed in 2023?
Anita Ramasastry (AR): The Silicon Valley Bank failure is the largest bank failure since 2008. This is significant. It's been a long time since the last failure that was as big as this one, which was Washington Mutual.
There are a lot of specific reasons why this happened. Silicon Valley Bank was a bank in the tech area — Silicon Valley, California. Many of its companies were tech startups, so there's a concentration of money from just one sector. When we started to see rising inflation rates and other things, many companies started struggling to get additional financing from venture capital and elsewhere. So, they needed to draw on the deposits they had at Silicon Valley Bank. When you have one industry that suddenly needs cash, many companies will go to the bank and try to withdraw all their money. That's a run on the bank. A bank doesn't have all that cash on hand. Silicon Valley Bank, in this instance, had invested that money because it's better for them to take that money from depositors and invest it. And when these tech startups wanted all their money in cash it resulted in a run on the bank.
UW Law: What happened to Silicon Valley Bank when this “run on the bank” occurred?
AR: When all these tech startups and companies started to withdraw their cash, Silicon Valley Bank had to find that cash because they didn't have it all. They had locked it up in low-yield treasury bonds that would pay interest. But given the rate of inflation — the interest rate was under 2%, very low — the bonds were worth more if they were held for a long time. But Silicon Valley Bank had to sell them quickly and at a loss. So, what happened was Silicon Valley Bank incurred a huge loss. As a result, they had to try to raise more money by issuing their own bonds on the open market. All of that created a perfect storm, where it led to even more worry among their customers. So, it was just one of these things where you ended up with an insolvent bank because they didn't have the liquidity they needed.
UW Law: Does one bank failing cause a “domino effect” where other banks fail as well?
AR: This is what we worry about. I'm a former bank regulator — I used to work at the Federal Reserve — and this is what we call contagion or systemic risk. Banks are interlinked and so if there's a run on one bank, that may lead to a lack of confidence in the market and runs on others.
We've seen a little bit of that. There's another bank, Signature Bank for example, that is more of a regional bank that also needed to be bailed out by the Federal Deposit Insurance Company. Fortunately, though, the Federal Reserve has been proactive in addressing this issue to try to contain that contagion.
UW Law: Why are bank failures difficult to predict?
AR: I think that's the question now. On May 1, Congress will hold hearings around the question, “Why did the Silicon Valley Bank failure happen?” There are lots of different theories or debates going on right now about that. It shouldn't be difficult to predict after 2008, right? There were a lot of safeguards in place to prevent this from happening again. That was the subprime mortgage crisis where it was just one of these situations where so many people took out subprime mortgages and were highly indebted. They couldn't pay these loans. And the property market started to collapse. The banks, as a result, weren't getting payments on the debts or the loans they issued. So, it was a big problem. There are meant to be safeguards in place where banks are examined and regulated so they don't engage in super risky behavior.
Ultimately, the money that goes in as deposits is invested or is loaned out, but you want to keep enough money in the bank to prevent panics. There needs to be enough liquidity. But, more importantly, you want to make sure that the investments the banks are making are not too risky. For example, a bank shouldn't put all of their deposits into cryptocurrency. That would be super risky. So, there are guidelines around the kinds of things banks can do with our money. That's what I mean by safety and soundness. It's really important.
Also, banks are complex and may have different kinds of branches or activities. One might have a credit card unit and also might do processing. But you want to look at the whole and make sure it's financially solvent. Silicon Valley Bank was examined by the Federal Reserve in San Francisco, and it didn't get a complete clean bill of health. There's a concern about whether the regulators did enough about where Silicon Valley Bank was investing depositor money. Was it too concentrated in one sector?
UW Law: Did the deregulation of 2018, which weakened the rules for banks like Silicon Valley Bank, factor into the bank’s failure?
AR: We're not really sure yet. If that was the reason for the failure of Silicon Valley Bank it may be a lesson to say we shouldn't loosen up on the reins. That's a different matter, but we still need to get to the root causes of this one crisis.
UW Law: How are bank account holders protected in the event of a bank failure?
We have the Federal Deposit Insurance Corporation, which insures our deposits up to $250,000. So, for somebody like me, $250,000 is a lot of insurance. It means that the government will make sure that my deposit is protected up to that amount. The challenge for Silicon Valley Bank was that 88% of their depositors were high-value depositors that had money above $250,000. So, their insurance protected them for very little of what they had on deposit.
Once the bank closed in mid-March, people were saying “Gosh, what's going to happen? These companies need money. They need to pay payroll. What are they going to do?” As it turns out, there is an additional safeguard that can be used, which the Federal Reserve used here. They made all the depositors whole. They protected all their money. So, they went above the $250,000 threshold. Now, a lot of people are saying, “Well, it's the taxpayers who are bailing out these depositors. That shouldn't happen.” That's not the case. There's a special assessment that's made on the individual banks that pay into this. So, it was actually funded through a charge on other financial institutions.
UW Law: Is there anything that account holders should keep in mind if their bank fails?
For most people, they should rest assured that they have $250,000 worth of deposit insurance. What we're seeing now, I think, is a larger issue that we learned with the FTX failure — you don't have that deposit insurance like you get at a bank. A bank is the only place where the government offers that kind of protection.
