“Trust is built in drops and lost in buckets”: Silicon Valley Bank was built over 40 years but collapsed in just 48 hours. Why? What are the lessons learned? Complex narrative simplified.

Let’s start with the first principles, for illustration purposes consider the following scenario.

1. Customer deposit $100 at the bank at a 1% savings rate, and the bank lends $100 to US federal reserve treasury for 1 year at a 4% coupon rate (interest rate) payable at the end. At the end of 1 year, the fed will return $104. Bank earns a net interest margin of $3.

2. In the middle of the year, the fed increased the interest rate to 5% for all future borrowings. Banks earn 5% for all future lending. Bank will earn 4% if they hold until maturity i.e. 1 year for the current holding.

3. Unexpectedly, the customer decides to withdraw $100 in the middle of the year. Bank will have to liquidate the US treasury in the market to meet the obligation. US treasury will trade at a discount of c. $95 to account for the prevailing higher interest rate and future expectations. Bank not only lost $3 of interest margin but they have incurred an additional $5 loss on the fire sale.

4. When the interest rate goes up, the bond prices fall. Fed has increased interest rates from 0% to nearly 5% in the past 12 months.

What happened at Silicon Valley Bank

1. SVB is a niche bank catering to VCs and the start-up industry, the increased deposit outflow was underpinned by lower VC funding and a higher short-term interest rate on offer in US treasuries.

2. SVB invested most of the customer deposits in the safest securities i.e. US treasuries and securities backed by the federal reserve.

3. They are the safest investment only if it is held until maturity, SVB was forced to liquidate in-between in an increasing interest rate environment incurring a $1.8Bn loss.

4. SVB announced they will raise additional capital through $2.25bn share issuance on Wednesday, which surprised the market and triggered fear and run on the deposits. The customer withdrew staggering $42bn deposits within 48 hours, and as a result, SVB ran out of cash and ended with a $958m negative cash balance by close of business Friday.

What are the lessons?

1. In an uncertain, volatile, and interest rate-tightening cycle, liquidity is key for both corporates and individuals. Cash is king and most importantly communication is key- minimize negative surprises.

2.  For the layman, maintain sufficient emergency /rainy day cash balance to pay for the potentially higher monthly mortgage payments and higher utility bills to avoid forced liquidation of personal belongings at a discount in a fire sale.

Note: Views are personal and certainly not investment advice. The article is oversimplified for educational purposes.

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