Silicon Valley Bank: A Story of a Collapse

20.03.2023

The rise in interest rates and the change in the focus of the high tech industry brought about a collapse of the 16th largest bank in the United States. Prof. Benjamin Bental, a principal researcher and head of the Taub Center Economics Policy Program, explains

The founders of Silicon Valley Bank say that the idea behind founding a bank specifically for tech sector came about during a poker game – a story that reflects perhaps the founders’ tendency to take risks. The bank, which was founded in 1983, in San Jose, California, entered a field that was undeveloped in those days: giving loans to start-ups. In general, these were young companies financed at the beginning of their journey by venture capital funds; money tended to run out just before  the product started yielding income. Here is where the bank entered the picture. After checking and consulting  with venture capital funds, the bank gave bridging loans to the companies. The business relations formed by the bank with the funds served to the advantage of both sides: the bank connected the funds to the start-ups, and the funds directed the start-ups they had invested in to the bank in conjunction with their business activities: relationships with suppliers, clients, and payment of salaries. Naturally, these companies remained clients of the bank even after they grew out of the start-up phase and became established companies.

In 1995, the bank moved to Santa Clara, a center of any number of large high tech companies, and it expanded its activities. In 2002, the bank began to act as a private banker to the wealthy of Silicon Valley and entered the area of real estate. In the framework of its international activities, in 2008, it established a branch in Israel that served the local high tech industry.

At the time of the collapse of Silicon Valley Bank, it was the 16^th largest bank in the United States, with total assets of some 212 billion dollars. At the end of 2022, loans to venture capital funds totaled 56% of the banks loans, and 9% were loans to start-ups. According to its reports, in 2022, the bank served half of the health and bio-tech enterprises funded by venture capital. Estimates are that about a quarter of the high tech companies in Israel were clients of the bank.

So how did such a large bank collapse?

The collapse stemmed from two parallel developments that fed into each other. The first is the quick rise in interest rates. In an attempt to rein in inflation in the United States, the central bank, the Federal Reserve, raised interest rates in the past nine months by 4.5 percentage points. The second development is the recent trends in high tech, which has turned its attention to the area of AI (artificial intelligence). Naturally, a change of this kind requires some reorganization in the industry. These two factors worked to limit worldwide activities of high tech companies and the amounts of investment in them, particularly in start-ups. As a result, funders had to finance ongoing expenses out of their deposits and began to withdraw cash from their accounts. The rise in interest rates harmed the  bank’s liquid assets that were invested primarily in United States government bonds. The interest rate rises caused a decline in the value of the bonds market, and the bank was forced to sell at a loss in order to cover the cash withdrawals. In a matter of days, it became clear that the bank could not meet depositor’s demands thereby instigating a “run” on the bank as depositors tried to withdraw funds before the bank’s collapse. This situation forced the financial authorities in California to intervene, and on March 10, banking activities were halted.

As a matter of course, savings accounts in United States bank deposits are insured for up to $250,000, a significantly small amount relative to the majority of deposits in the Silicon Valley Bank. In an attempt to prevent the spread of the crisis to other sectors of the economy, the Secretary of the Treasury, Prof. Janet Yellen, in consultation with President Biden, decided to increase the insurance ceiling, and, in the end, depsitors were not hurt. Nevertheless, the loss of such a unique institution in the finance of high tech will continue to overshadow the field which is already experiencing a global crisis, and venture capitalists in Israel will have to find another institution in the United States to finance their activities.