The quick and unexpected collapse of the second and third largest bank collapses in US history sent shock waves throughout the markets. Silicon Valley Bank (SVB) collapsed last Friday and it sent both private and public companies scrambling to address what exposures they had with SVB and other banks that might be at risk. To top it off, this occurred on a Friday, meaning many executives and CFOs had to wait all weekend until Monday to take real action.
These concerns grew on Sunday when New York’s Department of Financial Services closed Signature Bank, in order to “protect depositors”, and appointed the FDIC as the bank’s receiver.
The subsequent decision by the Federal Deposit Insurance Corporation to protect all depositors of SVB as well has relieved some of the tension in the system.
The CFO Leadership Council (one of the biggest CFO leadership organizations) addressed this with an emergency meeting shortly after the news on Friday to give executives a platform to talk about what CFOs can do, especially those who banked with SVB.
“It’s probably the biggest business story for CFOs since COVID,” said Jack McCullough, president and founder of the CFO Leadership Council, noting that members of his group may be more directly affected because many of them are smaller growth companies.
What happened to SVB and why it collapsed
SVB held a lot of cash from companies that deposited money that these businesses used for payroll and other expenses. Since SVB catered mostly to tech companies, business was booming in the past few years thanks to the influx of investments in the tech industry.
As most banks do, they invested their extra cash, but instead of diversifying their funds, they invested heavily in long-dated US government bonds, including those backed by mortgages.
While it sounded like a safe investment, it appears that the bank forgot a simple rule of economics: bonds have an inverse relationship with interest rates. If SVB was able to hold the bonds until they matured then they would have been able to receive its capital back with nice returns.
But as the economic conditions worsened over the past year, tech companies started pulling more and more of their funds out for use. SVB didn’t have enough cash on hand and had to sell their bonds at significant losses in order to provide the cash needed to fulfill these requests.
As rumors started spreading that they were having trouble repaying cash, more and more companies ran to take out their funds. It took just 48 hours between the time it disclosed that it had sold the assets and its collapse.
Will this create a ripple effect?
SVB may have been a unique case as its customers were mostly startups, and primarily tech startups. Many of them were similar in that they raised millions or billions of dollars from VCs in the past few years and deposited most, if not all, at Silicon Valley Bank.
Another thing that set SVB apart from most banks is that the vast majority of its money was uninsured because it was over the $250,000 that is insured by the FDIC. Out of its total $175 billion deposits at the end of 2022, $152 billion were uninsured. That’s a much larger percentage — nearly 88% of uninsured to total deposits — than at many other banks.
Signature Bank as well had above-average levels of uninsured deposits and some atypical business uncertainty, including lots of dealings with cryptocurrency.
But will it spread to other banks?
The answer isn’t so clear.
It is possible that other banks could be on the same path to failure, given that they may have gotten caught up in the “easy money” during Covid and mismanaged their fixed-income securities portfolios during the interest rate hikes.
Other banks may be harboring paper losses on large fixed-income portfolios as well, although not as large as SVB. Securities portfolios ballooned to $6.26 trillion at the end of the first quarter of 2022, up from $3.98 trillion at the end of 2019 before the pandemic. If these banks need emergency liquidity and have to sell their fixed-income securities that have dropped in price, it could suffer large losses and potentially create a similar situation to SVB.
Risk consultant Kroll said that SVB’s client base and funding structure both suggest that it is unlikely to trigger a systemic crisis among systematically important financial institutions (SIFIs).
“The good news is that because SVB was particularly interest-rate sensitive, it is a special case. There may be contagion to other small community banks, but the systemically important banks are unlikely to follow in SVB’s footsteps,” wrote Megan Greene, Kroll’s global chief economist.
Although it seems that the FDIC’s decisions have averted a banking crisis for now, closing SVB and Signature Bank is a loss for many companies as bank consolidation means fewer options for borrowers. SVB offered smaller growing companies the financing that some larger banks wouldn’t and also paid higher than typical interest rates on deposits. While smaller startups might have less options for banking or might receive lower interest rates, a widespread crisis seems to be avoided for now.
How can CFOs plan for these scenarios
As a CFO, it's important to be aware of the potential impacts of bank collapses, even if your company doesn't have funds deposited in that specific failed bank. One significant impact (which might happen with startups now) could be a reduction in credit availability, which could make it more challenging to secure financing for investments or manage short-term cash flow needs.
Additionally, changes in interest rates may occur as the central bank and other financial institutions work to stabilize the financial system, which could affect companies with variable rate debt or those planning to issue new debt.
Another potential impact of a bank collapse is increased market volatility, which can make it more difficult to manage investment portfolios. As an experienced financial professional, it's essential to stay vigilant and proactive in managing risk during periods of financial instability.
Regulatory changes could also occur as a result of a bank collapse, which could affect companies operating in the financial sector or those regulated by financial authorities. CFOs may need to adjust their planning and compliance strategies to stay in compliance with new regulations.
Ultimately, most of these factors don’t seem to be big risks following the SVB and Signature Bank collapses. However, being aware of these potential impacts can help CFOs to be better prepared and to manage risk more effectively. By staying vigilant and proactive, CFOs can help ensure their companies are well-positioned to weather financial storms and continue to thrive in the long term.