We are witnesses to the spectacular collapse of Silicon Valley Bank (SVB), a notable institution that helped countless tech startups and other US firms. And now that the situation has (almost) settled, we can take a look at the full picture objectively and draw lessons that can be used to avoid repeating the same mistakes that led to this collapse.
Lesson 1: The Importance of Risk Management and Diversification
The failure of the SVB illustrates the hazards of overconcentration and a lack of diversification in business operations and customer portfolios. Due to its extensive position in the technology industry, the bank was exposed to a substantial degree of systemic risk. The scenario resembles the 2008 collapse of Lehman Brothers, which was caused by an overexposure to subprime mortgages and an inability to effectively manage the associated risks. Similarly, SVB’s exposure to the technology industry was so high that the bank was vulnerable to the effects of a downturn.
To reduce the likelihood of such a collapse, banks and financial institutions must diversify their assets and avoid excessive sector concentration. In doing so, they build a buffer against industry-specific risks and lower the possibility of consequences cascading throughout the financial system.
This lesson is not exclusive to banks; investors and businesses must also heed the advice to diversify in order to guard against unforeseen circumstances and industry-specific downturns. Diversity is the cornerstone of a resilient financial ecosystem, and SVB’s failure is a harsh reminder of its importance.
Lesson 2: The Need for Regulatory Supervision and Stress Testing
SVB’s downfall was partly due to the easing of regulatory control and the removal of mandatory stress tests for banks of its size, as a result of the enactment of the Economic Growth, Regulatory Relief, and Consumer Protection Act (EGRRCPA). This deregulation led to a lack of preparedness for potential crises and ultimately contributed to the bank’s downfall.
Throughout history, the benefit of regulatory monitoring has been repeatedly established. For instance, the Great Depression showed the inadequacies of a largely unregulated financial industry, leading to the establishment of the Securities and Exchange Commission (SEC) and the Federal Deposit Insurance Corporation (FDIC) . More recently, the 2008 financial crisis underscored the importance of robust regulation and stress testing, as many financial institutions were caught off guard by the severity of the recession.
The collapse of SVB thus serves as a cautionary tale regarding the risks of deregulation and the need for stress testing. Regulatory agencies must maintain strict scrutiny to ensure that banks are adequately prepared for any challenges.
Particularly, stress testing enables banks to discover vulnerabilities and implement corrective steps prior to a crisis, thus improving financial system stability.
Lesson 3: Executive Responsibility and Corporate Governance
The SVB scenario highlights another critical aspect of a well-functioning financial institution: executive accountability and corporate governance. Bank executives were found to have engaged in questionable practices, such as executing trades based on non-public information and awarding bonuses to employees on the brink of collapse. Not only did these activities undermine the bank’s legitimacy, but they also led to its demise.
The Enron scandal of 2001 is a great example of the negative effects of poor company governance and lack of executive accountability.
The executives of the energy company participated in fraudulent acts, concealing billions in debt and inflating profits artificially. This finally resulted in the bankruptcy of the corporation and the loss of tens of thousands of jobs and retirement funds. In response, the US government adopted the Sarbanes-Oxley Act in order to enhance company governance and executive accountability.
The case of SVB underscores the importance of maintaining a high level of corporate governance and ensuring that executives are held accountable for their actions. Boards of directors must provide effective oversight, and regulators must monitor executive conduct with vigilance. Moreover, organizations should develop clear reporting methods and establish an ethical culture to safeguard shareholders, employees, and the broader economy from the repercussions of unethical behavior.
Lesson 4: Public Perception and Market Confidence
According to SVB, the bank’s downfall was exacerbated by a loss of public trust, resulting in a bank run as clients panicked and withdrew funds. This phenomenon demonstrates the importance of public perception and market confidence to the stability of financial institutions.
As individuals lost faith in the financial system during the Great Depression, bank runs were a typical occurrence.
The FDIC was established in 1933 to restore customer confidence by insuring deposits and safeguarding client funds. During the 2008 financial crisis, a lack of confidence in the viability of financial institutions precipitated market volatility and necessitated substantial government involvement.
To preserve market confidence, banks must be transparent in their activities and have open communication channels with the general public.
In addition, authorities must create a transparent and consistent regulatory structure that builds confidence in the financial system. By doing so, they can prevent the disruptive impacts of bank runs and maintain the integrity of the financial system during difficult times.
Lesson 5: Depositors and Investors Must Have a Comprehensive Safety Net
The demise of the SVB highlights the flaws in the current financial safety net, leaving uninsured depositors vulnerable to the bank’s failure.
A significant portion of the bank’s clients consisted of technology startups and venture capitalists, many of whom held deposits exceeding the FDIC’s insurance limit of $250,000. As a result, the failure of the bank posed a threat to the livelihoods of countless individuals and businesses.
The history of financial crises demonstrates the importance of a comprehensive safety net for depositors. During the 1980s Savings and Loan crisis, the federal government was required to intervene in order to rescue depositors and stabilize the business. Likewise, the 2008 financial crisis resulted in the Troubled Asset Relief Program (TARP), which injected funds into failing financial institutions to prevent further collapse.
In light of the SVB scenario, policymakers and regulators must assess the sufficiency of existing financial safety nets and consider expanding them to encompass a broader range of depositors and investors.
In doing so, they can shield the economy from the cascading impacts of bank failures and guarantee the continuity of key financial services.
In essence, the collapse of SVB provides a unique chance to study the weaknesses of the financial system and learn from the errors that led to its demise. The depositors in this case were saved by the FDIC’s decision to guarantee the deposits, but until the insured limit is officially increased, the depositors will always carry the risk if there is another bank collapse. As Mark Twain once said, “History never repeats itself, but it does often rhyme.”
Contributed by Richard Yim, CEO of Quantum Engineering and Manufacturing; Forbes Asia 30 Under 30
Originally published: 5 Lessons to Learn from the Silicon Valley Bank Collapse
