Concerns about the stability of the banking industry and the broader economy have been heightened over the past week following a spate of headline-grabbing bank failures, including the collapse of Silicon Valley Bank (SVB).
We asked Columbia Business School faculty to weigh in on the unfolding crisis in the banking sector and offer their views on what went wrong. They also shared how SVB’s collapse could impact the technology industry and entrepreneurship, what should be done to strengthen the financial system, and the outlook for the rest of the banking industry.
Here’s what they told us:
CBS: Looking at SVB, what went wrong?
“SVB was a category 4 bank in terms of the size of its assets, primarily. That meant that SVB was exempt from liquidity coverage ratios (LCR) and net stable funding ratios (NSFR), which were introduced as a part of liquidity regulations. This exemption was given in the Trump administration. Bigger banks are subject to LCR and must report NSFR. LCR ensures that banks carry high-quality liquid assets to cover 30 days of cash outflow under stressed scenarios. Had SVB been subject to these regulations, it would have mitigated the problem and regulators would have had more time to respond. Likewise, NSFR would have penalized corporate cash deposits and forced SVB to have more required stable funding.
“But SVB was exempted. SVB invested lots of its deposits in fixed income securities to earn the interest rate spread between its fixed-income portfolio and deposit costs. As the Fed started to increase rates, the value of its fixed-income portfolio fell, and SVB took a big loss. SVB could not meet the demand from its clients to withdraw cash even by selling its portfolio at a loss, and FDIC had to take over. Bottom line: poor risk management [and] exemptions from prudential regulations that other big banks comply with.”
– M. Suresh Sundaresan, Chase Manhattan Bank Foundation Professor of Financial Institutions
“Simply, this was a bank run. SVB had a concentrated deposit base of tech startups, their founders, and investors. The last few years were some of the best for venture capital-backed startups that used SVB. This meant a huge run-up of deposits (startups don't spend all their capital raises at once). The typical VC financing round is a lot larger than $250,000 (the FDIC-insured limit). So SVB had a lot of uninsured deposits. Unfortunately, many of these startups with millions of dollars in the bank did not use methods to split their deposits into $250,000 chunks, leaving them uninsured. These are the kind of deposits that are at risk of a run.
“Next, SVB decided to transform many of these new deposits into longer maturity – but highly rated – investments such as mortgage-backed securities. This is a great strategy so long as all those depositors keep their money at the bank or interest rates fall. Instead, interest rates rose and the market value of those securities purchased with deposits fell. So, when the depositors started withdrawing, SVB had to sell securities at a loss. This turned into a run because many of the uninsured depositors were on the same Slack or WhatsApp channels chatting about their SVB worries.”
– Michael Ewens, David L. and Elsie M. Dodd Professor of Finance
“SVB used a massive amount of uninsured deposits to finance long-term assets. When the Fed raised interest rates to counter inflation, long-term asset value fell. Uninsured depositors worried they could get their money back, so they ran.”
– Kairong Xiao, associate professor of business
“Two things: The first is a mismatch in cash flow timing. SVB put their money into financial instruments that didn't allow them to access cash quickly. When startups started drawing down faster than expected, they found themselves in a cash crunch. Then, some influential folks convinced folks that this was a systemic issue and everyone freaked out and we had a bank run.”
– Angela W. Lee, professor of professional practice
CBS: How could this impact the tech industry and entrepreneurship?
“The tech sector was overheated with lots of capital looking for better returns. Even big tech firms like Meta, Google, and Microsoft have been laying off for some time. The crypto market has been embroiled in fraud and defaults. Hence, SVB and banks catering to tech companies were in trouble. There will be a negative impact on the tech industry, but the fitter companies will emerge and the weaker and poorly managed companies will fail.”
– M. Suresh Sundaresan
“In the short run, this will create challenges for zero revenue startups with SVB deposits that are still a bit difficult to withdraw. In the medium term, SVB's services – including pairing cheap debt with VC financings or letting VC investors borrow money for their investments – will significantly diminish as new entrants are unlikely. There will be some losers from this, but I do not think it will be a huge impact. This is because the VC industry raised a record amount of capital in the last three years. So long as most of the startups affected by SVB saw nothing happen to their customer base or business model, then there is money available (at a higher price) for quality startups.
“Longer run, this could impact the small bank regulatory environment that may increase the cost of banking for clients of these banks. SVB and similar banks emerged in part because the large banks – subject to the highest amount of regulation – often turn down startups as clients. Thus, increased regulation may lead to more unbanked startups with an upside of a safer financial system.”
– Michael Ewens
“Close to half of all listed US venture-backed tech and healthcare firms were customers of SVB. Most of their deposit balances exceeded the $250,000 deposit insurance limits. If the government had not bailed out the uninsured depositors, the tech industry would have suffered.”
– Kairong Xiao
“We have to separate startups from VCs and from the folks who invest in VCs. Startups will be fine in the short term because they will have access to their cash and will be able to make payroll. I do worry about their ability to raise funds in the medium term, as this situation has made investors quite nervous."
“VCs would not have been that impacted by the SVB situation. The reason is because when a VC fund says they are managing a $100 million fund, they don't have $100 million of cash in the bank. VCs typically do capital calls on a regular basis so they aren't sitting on a ton of cash."
"Folks who invest in VCs were probably not that financially impacted by SVB directly. But it's going to make a lot of folks wary about investing in this already risky asset class and that will impact VCs and startups in the medium term.”
– Angela W. Lee
CBS: What should happen next to strengthen the financial system and stabilize SVB depositors?
“The US Treasury has already guaranteed that all deposits are safe, even those corporate deposits in excess of $250,000. This means that FDIC is not collecting enough insurance premium to compensate for the massive increase in the deposits it is being asked to insure. The US Treasury is claiming that banks will pay a charge for this. It is unclear how SVB will pay this. Bank equity holders should get wiped out, and bonuses must be open to claw-backs.”
– M. Suresh Sundaresan
“The government has effectively bailed out all the uninsured depositors of SVB. The next step is to shore up confidence by disclosing more information about the financial condition of other banks. In the long term, the government should rethink the regulation of midsize banks. SVB was subject to the annual stress testing under the Dodd-Frank Act of 2010 because its assets were above the $50 billion threshold. The 2018 Economic Growth, Regulatory Relief, and Consumer Protection Act raised this threshold to $250 billion, effectively exempting SVB from regulatory scrutiny. The same thing happened for Signature Bank. The rollback of financial regulation since 2018 is an important factor that allowed this failure to happen.”
– Kairong Xiao
CBS: Is there a domino effect happening that will impact other banks in the near future?
“The potential for a domino effect is less than what we witnessed after the Lehman bankruptcy, as it is more confined to tech and crypto areas, and the Signature Bank failure suggests that it may affect property lending areas too.”
– M. Suresh Sundaresan
“I think the probability is quite low. The usage of uninsured deposits of SVB is an outlier: The median US bank uses 30 percent of uninsured deposits, but SVB uses around 90 percent. The other bank that failed, Signature Bank, is also an outlier in its exposure to crypto assets. So I don't think this is September 2008 happening again. At that time, 99 percent of banks were exposed to the collapsing housing market.
“Nevertheless, this is not a good time for policy makers to relax. Bank runs are inherently unpredictable. They are driven by human psychology, misinformation, and confusion. On Monday, we saw a huge drop in the stock prices of other regional banks. They essentially become guilty by association. This panic is caused by misinformation and misunderstanding about banks' interest-rate risk exposure. For instance, some observers claim that many US banks have massive unrealized losses due to interest rate hikes hidden by held-to-maturity accounting. This claim is ill-conceived because bank profits from insured deposits would increase with high rates, which hedge against the falling asset value. The key is whether banks have enough insured deposits or not. SVB did not, but most banks do. This is the reason why I think the banking system is largely sound. However, if enough people believe banks are failing, these beliefs tend to be self-fulfilling, as the Nobel Prize-winning Diamond-Dybvig model would predict.”
– Kairong Xiao
“I don't think so. I think that founders might do a bit of bank diversification in the medium term. The other thing is that I think we are going to see the rise of alternatives to VC like venture debt and revenue-based financing.”
– Angela W. Lee