The Collapse of Silicon Valley Bank: Lessons Learned from a Risk Management Perspective

The Collapse of Silicon Valley Bank: Lessons Learned from a Risk Management Perspective

The collapse of Silicon Valley Bank (SVB) in March 2023 was a major event in the US banking industry. The bank, which was the 16th largest in the country based on asset size, announced on March 8th that it intended to offer equity and preferred stock, and that it had suffered a USD 1.8 billion loss. Just two days later, the Federal Deposit Insurance Corporation (FDIC) was appointed as SVB's receiver. People wanted to know what had gone wrong, and whether the bank's collapse was preventable or not.

Deposit concentration was one of the key factors that led to the collapse of SVB. The bank serviced almost exclusively the venture capital (VC) industry, and was the leading bank with the largest exposure to this customer niche. In return for the bank providing funding and other services to its VC community, SVB requested that its customers place funds raised with the bank. As the VC industry grew and its customers raised additional investor funding, they also placed this cash on deposit with the bank. As a result, the bank’s deposits were highly concentrated within a very narrow depositor base, which set the stage for a depositor run on the bank.

FRM liquidity risk knowledge covers this concept. A central principle of liquidity management is funding diversity. The FRM learning objective compares and interprets different types of liquidity risk reports, and includes a discussion of the Large Deposit Concentration Report. This report identifies large depositors by either a deposit threshold amount or as a percentage of total bank liabilities. Had SVB prepared and reviewed this specific report, the bank would have clearly identified that its deposits were highly concentrated and could pose a future funding risk should they be withdrawn rapidly under a stressed condition.

SVB's liquidity portfolio management and balance sheet management also contributed to the bank's collapse. Through its banking activities, SVB engaged in maturity transformation as a standard course in its banking business. Maturity transformation is effected when banks borrow short-term to provide longer-term financing to their customers. The spread between the interest that banks pay and the interest they earn is the net interest margin. This funding and investment posture will create a mismatch between the duration (or risk sensitivity) of a bank’s assets and the duration of its liabilities.

In the case of SVB, this mismatch became extreme. The bank invested in U.S. government long-term Treasury securities and U.S. guaranteed mortgage-backed securities (MBS). At the time of purchase, these securities had very low coupons due to the interest rate environment and therefore were of longer duration (more interest rate sensitive) compared to higher coupon bonds of identical maturity or bonds of shorter maturity with similar coupons. The duration of these U.S. Treasuries and MBS was significantly greater than the duration of the bank’s deposits, which could be withdrawn at any time. This problem was amplified by the fact that SVB’s deposits included many individual accounts considerably larger than typical retail bank deposits and were highly concentrated in the technology start-up sector. Based on these characteristics, the duration gap of SVB was large.

In conclusion, the collapse of Silicon Valley Bank (SVB) in March 2023 serves as a reminder of the importance of adhering to the principles of risk management in the banking industry. The bank's failure to manage its liquidity and balance sheet effectively, coupled with its reliance on a narrow depositor base, led to its downfall. As a result, it is crucial for banks to implement best practices in liquidity risk management and funding diversity to mitigate the risk of a sudden depositor run. The lessons learned from the SVB collapse should inform the banking industry's efforts to enhance risk management practices and ensure the stability of the financial system.