Why Did the Silicon Valley Bank Collapse?

Silicon Valley Bank's collapse was caused by a run on the bank, rather than insolvency. The bank's management chose to sell $21 billion of bonds at a $1.8 billion loss, in part because many of those bonds were yielding only 1.79% while interest rates had risen significantly. Moody's was considering downgrading its rating, and the bank's management wanted to reassure investors. However, the bond sale and fund-raising had the opposite effect, causing the bank's smart client base of venture capitalists to withdraw their deposits en masse.

The General Atlantic equity investment could have been completed overnight, but the bank's management chose to sell convertible preferred stock, which couldn't be sold until the next day, leaving time for investors and clients to start doubting the firm and leading to an exodus of deposits. The bank's failure was due to poor communication and a vacuum of confidence created by management.

Underlying the failure was the bank's investment of deposits in low-interest rate bonds held on a long-term "hold-to-maturity" basis. As long as a bank doesn't need to sell "hold-to-maturity" assets to meet withdrawal requests, there is no problem. However, if a bank has to sell at a loss, things get complicated.

The bank successfully lobbied regulators in 2015 to loosen rules that might have prevented it from taking some of the risks it did. Silicon Valley Bank had a unique client base and appears to be an outlier, but there is already nervousness about some other small and regional banks.

The most pressing problem presented by the bank's collapse is for Silicon Valley itself. Venture capital firms that used the bank may struggle to gain access to their money and possibly that of their limited partners, including pension funds, that had forwarded money intended for investments. This, in turn, may make it hard to fund current and new investments or to rescue other companies inside and outside their portfolios. The fallout from Silicon Valley Bank's collapse is only just beginning to be felt.