Silicon Valley Bank is all over the news headlines and is the hottest topic in the finance industry this week. Silicon Valley Bank is a normal bank for individuals and businesses. They are the 16th largest bank in the United States. However, as the name suggests, many of their customers are tech companies and startups in Silicon Valley. This blog will help explain the bank run that happened last week and how it could impact your financial planning.
First, it is important to have a clear understanding of how banks work in general. At a basic level, banks accept deposits from customers (though checking and savings accounts), and then use this money to lend out through loans and other investments. They earn revenue from the difference between the interest rates on the loans and the interest rates on deposits. For example, they may pay 0.5% interest on a checking account, then turn around and lend that money out through a mortgage at 5% interest. The risk to a bank, is if every customer comes and asked for their money all at one time, they are not able to issue it because it is tied up in loans.
Banks are regulated by government agencies to ensure their safety and soundness and to protect customers’ deposits. They are required to hold a certain amount of capital to cover potential losses. There is also FDIC insurance, but that only covers up to $250,000 per account. So, if a bank account has $1,000,000 in it, only the first $250,000 is FDIC insured.
Back to Silicon Valley Bank. They had purchased $80 billion in US treasuries at a 1.6% interest rate. Treasuries are one of the safest investments you can make if they are held to maturity. However, US treasuries are paying around 5% right now. If Silicon Valley Bank tried to sell these treasuries, no one would want to buy them since they could buy a new treasury at a 5% interest rate, since the Federal Reserve has drastically raised interest rates over the last year. Only realistic option is to hold them to maturity, then reinvest them back into treasuries that are paying a higher interest rate when the time comes. The other option is to sell them (at a loss) if they need to cover distributions to clients (which happened in this case).
Now let’s look at what is going on in the tech industry, which makes up most of their customers. These tech companies are generally funded and backed by private equity or venture capital firms. Tech companies have not been doing well recently, so it has been very hard for them to raise money lately. So, what do they do? They spend money that they have saved in the bank to cover payroll, expenses, etc.
Last week, as this is all going on, Silicon Valley Bank announced that they were raising capital. A normal thing for a bank to do, especially if they are not able to sell their $80 billion worth of treasuries at favorable prices to come up with liquidity. Around the same time, Silvergate Bank collapsed. These two were totally unrelated. Silvergate dealt with Cryptocurrency and was not a normal bank like Silicon Valley Bank was. Since this happened at the same time, people started to question it.
Peter Thiel, who manages Founder’s Fund, which is a venture capital fund that back many tech startups, told all of these companies in the fund that does their banking with Silicon Valley Bank to pull their money out. Word started to spread, and many customers started pulling out their money, leading to a bank run. This has happened many times in history.
Silicon Valley Bank did not have enough liquid money to come up with all the capital needed once the bank run started. They had many business accounts that had well over $250,000, meaning many customers were not FDIC insured. Only 7% of the bank’s cash was FDIC insured.
Up to this point, there were three outcomes:
Option three was what happened. The FDIC announced that they would back all of the depositors money, but the bank as a whole still failed. This is the second largest bank run in history. The largest was Washington Mutual in 2008, but 100% of customers also received their money back.
Should you be concerned about your investments or banking? Silicon Valley Bank is a small bank compared to large banks in America. They had $209 billion in assets, but JP Morgan Chase has $3 trillion in assets. Bank runs could happen to any bank, but are much more likely in smaller banks.
A few tips are:
As far as your investments, the custodian that is holding the investments would have to fail. A custodian is a financial institution that safeguards assets on behalf of clients. At EWA, we use Fidelity and Charles Schwab as our main custodians. Custodians are typically separate entities from the companies whose assets they hold. Meaning, even if a custodian failed, the underlying investments should still be intact and unaffected. If a custodian were to fail, assets could be transferred to a new custodian or liquidated, or a government agency could step in and oversee the transfer or liquidation process, much like we saw with Silicon Valley Bank.
For EWA clients, we did much due diligence when selecting Fidelity and Charles Schwab as our custodians, and ultimately wanted to pick custodians that would best serve our clients. Custodians are covered by SIPC insurance, which covers $500,000 in investments and $250,000 in cash, for a total of $750,000 per client. Fidelity offers additional protection above SIPC limits, which is up to $1 billion across all client accounts, $1.9 million in cash per customer, and no limit on securities. Fidelity also manages over $10 trillion in assets, making them one of the largest financial institutions in the country. Charles Schwab and Fidelity both have a long track record of being large trusted financial institutions.
If you have any questions on protection strategies for your specific situation, an EWA advisor would be happy to help.
Equilibrium Wealth Advisors is a registered investment advisor. The contents of this article are for educational purposes only and do not represent investment advice.
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