The unmanaged risks that caused Silicon Valley Bank to fall

Since Silicon Valley Bank has gone bankrupt, it has been all over the news and caused stress on the financial markets and amongst monetary regulators. Rightfully so, as it is known to be the largest bank to fall since 2008. The collapse happened due to a number of reasons, the most prominent being the absence of proper risk management. FD wrote there was not even a CRO before 2022 [1].

What risks were left un-managed? And how did this contribute to the bankruptcy?

Interest rate risk

Interest rate risk has gained the lion share of attention as it was big for SVB.

On December 2022; 173 bn [2] of their 195 bn liabilities (92%) were (savings) deposits, which are typically free for withdrawal at any moment. As a result, the effective duration of these liabilities were relatively short (+ 4 year). However, when the FED started raising the interest rates, SVB also had to raise the interest rates on deposits. In turn, this drove the bank towards higher costs.

On their asset side, 91 bn was reported as 'held to maturity' securities, which in this case were mostly mortgage-backed securities with a duration > 10 years. Here, the rising interest rates had no nominal effect since the interest rates were fixed until maturity. However, the economic value of the securities drastically dropped, until only 60% of the nominal value [3]. However, this loss would only be taken if the securities had to be liquidated in the case of liquidity issues.

Uh oh..

Liquidity risk

As said 92% of SVB’s funding comes from deposits. Typically, some clients will withdraw money and some clients will deposit money. However, banks should account for the possibility that an unusual number of clients withdraw their money. On Dec 2022 they had 13 bn in cash (or equivalent) in store, such that 7.5% of the deposits were covered for withdrawal.

Concentration risk

Not only were the interest rate risk and the liquidity risk left un-addressed, it turned out that SVB was highly concentrated bank in terms of clientele which held deposits (and loans). As a well-known bank for (tech) start-ups, many of this type of companies held their account at SVB. A market change in start-up land, can have larger impact on SVB than on another, well diversified bank. This led to an even higher liquidity risk.

Events

(1) A change in start-up land happened slowly when the investor market was becoming increasingly difficult. Start-ups are using up their savings, withdrawing the deposit from SVB - concentration risk.

(2) State bond returns increased over deposit returns causing clients to move to safe bonds as a more lucrative investments than deposits. These increased withdrawals cause even more liquidity issues.

(3) SVB required cash to facilitate the withdrawals, forcing them to sell the securities, for which the value had dropped due to increased interest rates - interest rate risk. In the end, leading to their collapse.

European banking

Luckily all the European banks which are under supervision of the ECB (or DNB) are managing the risks which lead to the end of the Silicon Valley Bank.

Interest rate risk is governed by the interest rate risk in the banking book (IRRBB) [4] and forces banks to apply stress test scenario’s and manage the risks.

Liquidity risk is governed with the internal liquidity adequacy assessment process [5] (ILAAP). Within the ILAAP, the concentration of clients should be addressed according to the guidelines for concentration risk [6].

It is good to realize that the regulation is there for a reason and bad things can happen when it is ignored.

[1] FD March 14th

[2] Yahoo finance: https://finance.yahoo.com/quot...

[3] FD March 14th

[4] https://www.eba.europa.eu/regu...

[5] https://www.bankingsupervision...

[6] CEBS Guidelines on the management of concentration risk under the supervisory review process (GL31)