What can businesses learn from the Silicon Valley Bank (SVB) collapse — even if they are not a bank?
As it turns out, a lot.
Recently, SVB imploded and was taken over by the FDIC after experiencing an old-fashioned run on the bank. Banks are highly levered and illiquid — they take liquid deposits and use the funds to make loans that are fundamentally
illiquid.
When depositors lose trust in the bank’s ability to redeem deposits at will, they rush to take their money out while they still can.
At that point, things can snowball quickly. Depositors of other banks, seeing what is happening, may lose trust in their bank as well, starting a banking panic. In the SVB case, government intervention was needed to make sure this did not progress.
But your business is not a bank, so why care?
Because when customers and creditors lose trust in your business, they run too.
In working with companies in financial distress, the tipping point that drives really bad outcomes is often when critical vendors whose payments have been stretched, suddenly go from stretched terms to COD and a repayment plan.
For example, in one situation that I am aware of, the private equity firm that owned the majority of a firm in financial distress fired the founders and minority owners. On the way out the door, the founders sent goodbye messages to their Asian suppliers.
The suppliers promptly eliminated terms; payment was now required with every order!
The cash drain was so severe, lenders had to advance funds to the company. That wiped out the majority owner’s equity.
Trust is the Coin of the Realm
Initially, what happened at SVB was an
idiosyncratic problem
.
That is, it was specific to just SVB. But the run quickly spread to other banks and became a
systemic problem
—
all
banks perceived to be similarly situated, even if better managed, were thought to be unable to pay out deposits on demand.
The key takeaway here is that
your business needs to be prepared for systemic problems.
Usually, that means industry problems. But it could also be a customer segment, geographic exposure (domestic or international), common labor union, etc. Your business may not cause the problem, but it still must deal with it.
As George Schultz, the former Secretary of State, Labor, Chairman of Economic Advisors, and much more, once said, “
Trust is the Coin of the Realm
.”
Trust has three key elements:
- Do what you say you will do
- Show respect to others
- Take the high road, even when not expedient
SVB’s problem was that customers didn’t believe SVB
could
do what it said it would do — pay out deposits. Further, SVB didn’t take the high road.
What Happened?
During the pandemic, SVB’s deposit base increased substantially — by much more than it could lend.
So it invested in long term Treasuries. When interest rates began to rise, the market value of those bonds declined (bond prices go down when interest rates go up). SVB was locked into losses on the bonds when they sold them to fund customer withdrawals.
Banks are supposed to know that interest rates can rise (in banking lingo, this is called “interest rate risk”). So they should invest in short-term assets that soon roll over and benefit from higher rates. They are also supposed to model, monthly, what will happen if rates rise or fall, and prepare accordingly.
Had SVB done the projections,
it would have seen that either it would have to pay much higher rates on its deposits or lose those deposits.
In their situation, that meant selling Treasury bonds at a loss.
Further, and unique to SVB, many of their deposits were venture capital (VC) investments in startups. Traditionally, these startups spend the cash, drawing down deposits, and those deposits are replaced with new VC investments. But VC funding dried up last year, so there were no new deposits. SVB had an idiosyncratic risk and they were not prepared.
To make things even worse, the bank did not take the high road.
It stretched in an effort to improve yield and bought longer term Treasurys than it should have. (The longer the term, the more the price of a Treasury falls when interest rates rise.) SVB did hedge much of the interest rate risk with swaps, but it sold those swaps in the third and fourth quarters of last year in what appears to be a move to boost profits.
The collapse of SVB then led to market fear about other banks and their ability to redeem deposits. The problem had become systemic and other banks faced liquidity challenges they didn’t create, until the government intervened.
In the end, SVB simply did not prepare for standard industry risks or clearcut risks that were unique to them,
both of which led to an eventual — and existential — loss of depositor trust. They weren’t crooks, they just didn’t execute.
What Should Your Business Do?
You may not be a bank, but SVB serves as a cautionary tale for any business.
Some suggestions, to make sure this kind of thing does not happen to you…
Understand the critical aspects of your business and make sure you execute them well.
SVB did not understand interest rate risk.
Compare this to a client of mine that gets it right — a manufacturing company that buys ore from around the world and processes it.
The supply chain is relatively unreliable for a host of reasons, so my client uses multiple suppliers and keeps a relatively high level of inventory.
During the pandemic, there was a spike in demand and the low-cost supplier restricted supply. Many competitors ran out of raw material because they kept low inventories and only bought from the low-cost supplier. My client already had access to more expensive alternatives and kept operating (it did raise prices to cover the cost increase).
Stay out of the weeds by forecasting high-level business drivers. Change key assumptions based on the things in your industry that can go wrong.
Just as banks should map out what happens when interest rates rise or fall, you need to do the same regarding the key variables in your business.
Make sure the people and process aspects of critical functions work well.
Review the functions periodically and make sure those positions are filled with quality people.
Often this goes beyond just who is hired,
but also how people are trained and developed so they can take on these critical functions.
Be prepared for systemic challenges.
Bank runs are a classic example. The supply challenges of my client are another.
Conclusion
For any business to survive, trust is essential.
Customers won’t buy from you if they don’t think you can deliver. Vendors won’t sell to you if they don’t think they will be paid. And trust is about more than just character — it is also the ability to execute.
The SVB example and the resulting contagion are an important reminder
of what it takes to maintain the trust of your customers, suppliers, lenders, and employees, so that your business can perform and deliver as expected.
