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Tech Startup Catastrophe Simplified: The Fall of Silicon Valley Bank and Its Impact

Silicon Valley Bank (SVB), a bank known for its focus on serving tech startups, has experienced a catastrophic collapse. The bank had been ranked as one of the top 20 largest banks in the US and had provided financing for nearly half of all US venture-backed technology and healthcare companies. The bank's collapse was caused by a combination of factors, including its investments and the economic climate.

Factors that resulted in SVB's collapse

One of the factors that led to the bank's collapse is what some consider a tech bubble that started in the middle of the COVID-19 pandemic (2021). Starting in this period and continuing today, the Federal Reserve cut interest rates significantly to support the economy. People started to heavily rely on technology during desperate times and with the combination of low interest rates (capital was cheap) this lead to a surge in the number of tech startups founded being backed by venture capital firms. With SVB catering to startup tech founders, this resulted in the bank receiving huge deposits from all of the funding raised by these young companies, which tripled from $62 billion to $189 billion.

With so much cash on hand, the bank had to make a decision on how to invest the money. They opted to buy long-term bonds, specifically mortgage-backed securities, which are sensitive to interest rate changes (a rise in interest rates leads to a drop in the value of the bonds). Many of SVB’s investments also had low interest rates resulting in low returns for the bank. However, this decision came back to haunt the bank as venture funding for startups suffered a 50% year-over-year drop in the 3rd quarter of 2022 partly due to the Federal Reserve consistently increasing interest rates in order to slow down the economy and rein in inflation. Navigating through the slowdown, startups continued to spend cash in the bank to support their operational expenses causing a significant drop in deposits in February 2023 (more cash was flowing out of SVB than coming in). SVB responded by selling $21 billion of its long-term assets and reinvesting the proceeds into short-term assets that are less volatile and have higher interest rates. The sale resulted in a loss of $1.8 billion.

Public's Response

This caused a panic among the bank's clients, and dozens of venture capitalists advised their portfolio companies to pull their cash from SVB. Companies started withdrawing their money, resulting in $42 billion in withdrawal attempts. The bank was unable to handle such a large amount of withdrawals and responded with a failed attempt to sell $1.8 billion of stock to have more liquidity (cash on their balance sheet). As a result, it became insolvent. The California authorities intervened and transferred the bank to the FDIC where initially it was thought that only deposits within the $250,000 FDIC insurance would be accessible with the rest “stuck” for an undetermined period of time. This left startups looking for other ways to pay for their daily operations (including payroll).

Measures to prevent a wider economic crises

On Monday, March 13, the FDIC ensured that customers would have full access to all of their deposits, whether within the FDIC insured insured limit or above it. In response to what happened to SVB, the Federal Reserve took swift action to prevent a broader economic crisis. They launched several crisis lending programs, including the Bank Term Funding Program, which provides short-term loans to banks that pledge high-quality assets as collateral. They also established the Secondary Market Corporate Credit Facility to support the corporate bond market, and the Municipal Liquidity Facility to help state and local governments facing financial challenges. These programs have helped stabilize the financial system by providing liquidity to banks and other market participants.

The inevitable ripple effect

Overall, the Fed's actions have helped prevent a wider economic crisis and ensure the financial system remains stable. However, it cannot be denied that the fall of Silicon Valley Bank serves as a stark reminder of the fragility of the financial system, especially for industries that rely heavily on venture capital. With one of the key players in the tech startup financing ecosystem collapsing, it is likely that we will see a ripple effect throughout the industry. Only time will tell what the long-term effects of this collapse will be, but one thing is for sure - the tech industry will never be the same.



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