The federal government has taken control of Silicon Valley Bank (SVB), a California-based startup bank whose losses have caused panic in the startup industry and the banking world.
According to the New York Times, the Federal Deposit Insurance Corporation (FDIC) created a new entity on Friday to take control of SVB, called the National Bank of Santa Clara.
How it started: On Wednesday, the small California-based Silicon Valley Bank (SVB) reported a loss of about $1.8 billion on its investments after starting what Insider called a “sell off” of its bond portfolio. This was done to “reposition the balance sheet to current exchange rate terms,” the bank said in a presentation, adding that it plans to raise $2.25 billion from the sale of shares.
According to Bloomberg, this has led to concerns about the bank’s stability, leading leading investors and VC firms to privately ask or advise their startups to withdraw money from the bank, including Founders Fund, Union Square Ventures and Coatue Management.
This sparked a “classic bank run” by John Wu, CEO of blockchain technology firm Ava Labs, told Bloomberg TV. “And when the bank run starts, you don’t want to be the last guy there.” (Ava Labs is supported by Andreessen Horowitz, an SVB client.)
More emphatically, as described by Insider on Friday morning before the federal government’s move was announced, “Everyone is crazy about SVB because everyone else is crazy about SVB.”
What is a Bank Panic?
Bank runs are when people withdraw money from one bank, and the panic of this action triggers withdrawals at other banks. This may lead to banks running out of cash reserves. The Federal Reserve requires banks to hold just 10% of “bank demand deposits and checks”. Therefore, if everyone tries to withdraw their money immediately, the bank may fail.
It is a psychological and financial phenomenon that can cause widespread problems, as happened during the Great Depression when American customers rushed to withdraw money, causing thousands of banks to collapse.
The thing about panic in the financial system: it’s contagious. “Contagion” occurs when a difficult event in one part of the financial sector spreads to other parts of the system. Many companies were affected during the 2022 crypto crash that saw startups drop from FTX to Celsius.
What’s going on with the Silicon Valley bank?
Silicon Valley Bank is headquartered in Santa Clara. On its website, which lists clients like Shopify and the legendary venture firm, and Andreessen Horowitz, it calls itself “a financial partner for investors in the innovation ecosystem and beyond.”
“They’re probably the most popular startup bank,” said Elizabeth Yin, general partner at Hustle Fund Entrepreneur.
What went wrong? Put simply, as noted by Insider, SVB has found itself in a difficult position after rising interest rates that make it more expensive to borrow money, which is reflected in the world of venture-backed start-ups.
Startups often borrow capital from venture capitalists in hopes of a return, but it’s a risky industry and it got tougher after the Federal Reserve began raising interest rates in hopes of curbing inflation. In particular, the bank’s strategy meant it suffered more from rising interest rates, the Times reported.
After the bank announced its losses on Wednesday, people in the startup world such as Activant Capital advised people to exit the bank. SVB shares fell by around 60% on Thursday.
Yin added that she had emailed more than 400 companies in the Hustle Fund’s portfolio about the matter. “If a bank run is already happening, you don’t want to be a loser,” she explained, even though she didn’t want to start a bank run.
Michael Burry, z Big shortcut fame, wrote in a now-deleted tweet on Thursday: “We may have found our Enron today.”
There was also wider unrest in the banking world. Bank of America and JPMorgan shares fell 5% on Thursday, Reuters reported. The KBW Bank index on Thursday recorded a worse performance since June 2020, as noted by Bloomberg.
Bill Ackman, an investor in Pershing Square Holdings, had previously called on the government to bail out the bank.
Failure @SVB_Financial could destroy an important long-term driver of the economy, as VC-backed companies rely on the SVB for lending and holding operating cash. If private capital cannot provide a solution, a highly dilutive bailout favored by the government should be considered.
— Bill Ackman (@BillAckman) March 10, 2023
FDIC insurance covers up to $250,000 in deposits, meaning those with more in SVB can only expect a partial refund, according to the Times.
Yin said she hoped a giant like JPMorgan could buy up the bank and cover any potential losses on customer deposits, as it did with Washington Mutual after the 2008 recession.
But beyond that, Yin sends emails and calls trying to help founders figure out what to do with their assets and how to communicate with investors and employees.
“It’s the only thing I’ve been working on for the last 24 hours,” she said. “There are consequences everywhere and I think we just spent a lot of time helping people stay calm,” she added.
Ashley Tyrner, founder and CEO of FarmboxRx, which works with programs including Medicare to bring food to underserved communities, said Entrepreneur her company has “eight digits” in SVB. Tyrner declined to say the exact amount on the record, but Entrepreneur watched a screenshot of the company’s bank deposit.
She said she was unable to withdraw the company’s money from SVB on Thursday, even after its chief operating officer sent her on vacation in a panic over the situation.
“We’re very lucky that this won’t bankrupt the company,” she said Entrepreneur. But if dozens of startups only received $250,000 of their deposits, then “I’m the least of the problems.”