The rapid departure of Silicon Valley Bank brings together three critical points of the current economic and financial situation: venture capital difficulties, the effects of monetary policy on bank balance sheets, and the objective crisis of the technology sector.
Market traders must have rolled their eyes the night of the 9th of March as they noticed a stock tumble, losing 60% in hours and dragging the benchmark US banking sector index down by eight percentage points. What had happened?
The answer lies in one name: SVB Financial Group, a financial company that controls (or rather controlled) a small bank based in California, in Santa Clara, and with a name as evocative as it is unknown to most people, at least until Thursday, March 9th: Silicon Valley Bank.
The facts are now known. The bank – 212 billion dollars of assets, less than a tenth of that of JP Morgan – announced on the evening of March 9th that it intends to raise 2.25 billion dollars on the market, necessary to buffer the effects of the sale of 21 billion dollars worth of portfolio securities. The sale that generated – given the prices on the bond market – a loss in the first quarter of 2023 equal to 1.8 billion dollars. Numbers, huge for such a small bank, and the epilogue was its closure by the California supervisory authority on Friday, March 10th.
What is worrying about this story whose contours are still to be clarified is the cause that prompted SVB to undertake the emergency operation which later turned out to be fatal: the request for liquidity from customers. Considering it is a bank located in the middle of Silicon Valley, the customers in question are mainly technology start-ups. Mostly innovative companies, which draw substantial nourishment from venture capital, a form of investment that the race to raise interest rates is making less sustainable. The decline in investments and greater risk aversion are at the basis of the increase – beyond the possibilities of the bank – in requests for liquids from SVB customers. Deposits thus fell from USD$189 billion at the end of 2021 to USD$173 billion at the end of 2022.
Small bank, small inconvenience one might say. But this story brings together three elements which, seen together and in a medium-term perspective, could prove to be a real tip in the balance for financial stability. The first element is the rise in interest rates and its implications for investments; the second is the exposure to losses that a very restrictive monetary policy entails for the banking sector; the third is the state of objective difficulty in the technology sector.
According to research by Partech Partners, in 2022 financing through the Venture Capital tool in the USA fell by 35% (the Economist spoke of VC winter to describe the slowdown in the sector). In recent months, putting money into a company, especially an innovative one, has become an operation with an uncertain outcome, on the one hand, due to the rising cost of money and on the other due to a return on investment that is far away in time and at the mercy of the situation. Thus, the fact that many of the lenders of SVB’s start-up customers, upon announcing the maxi operating loss, hastened to advise them to lighten the deposits accumulated in the bank, causing the subsequent bank run, does not make much of a stir.
Furthermore, the level of interest rates has as a consequence a sharp reduction in the value of the securities held by the banks. The rule is well known: if interest rates rise, bond yields rise and their price falls. A bank forced to quickly release funds in such a scenario risks incurring substantial losses. This means that on the one hand, the banking system is forced to adopt even more conservative risk policies, tightening the credit lines, and on the other, it is exposed to greater fragility in the event of a crisis.
The technology sector is the third element that deserves attention. The rate hike is penalising it on the stock exchange but not only. From the end of 2021 to today, the NYSE FANG+ Index has dropped 32 percentage points. But to understand the profitability problem affecting the sector, it is important to take a look at the job cuts: in 2023, 35% of the personnel cuts announced in the USA belong to companies in the technology sector. And if things do not go well for the big names in the sector, the appeal of innovative start-ups is significantly reduced. Without forgetting that the fragility of tech is worth 600 billion dollars globally. In fact, in 2021, the total amount of capital invested in start-ups in the sector amounted to that much.
These three elements are held together by a common thread which is none other than the trend of the economy in the coming months. The arrival of a “tough” recession can be the fuse capable of detonating something very similar to a financial crisis. And after all, the sad departure of Silicon Valley Bank (which was followed by that of New York’s Signature Bank), could be a sign of an incoming slowdown; central banks risk finding themselves with the match in hand.
Featured image: FT montage/Reuters