Collapse of Silicon Valley Bank: Lessons we can Learn

I am rather late to the party. But I reckon it is better to be late than never. The internet is flooded with articles that explain the origins and technicalities of the collapse of Silicon Valley Bank (SVB). I better not repeat. Instead, I would like to shed some light on some of the lessons that we can learn in relation to managing our personal wealth and investments.

It has been three weeks since it happened. Here is a quick recap in case the story had already been buried in your memory. SVB, as the name suggests, specialises in serving clients from the “silicon valley” - i.e. tech - industry. A major part of its business was lending money to tech start-ups. As covid hit, coupled with a slowdown in tech, SVB looked elsewhere to allocate its assets. SVB then apportioned a significant amount of its assets in long-term fixed income securities, which allowed it to profit from a thin spread of interests between deposit and securities. As the Fed and central banks across the world raised interest rates to combat inflation, the prices of these long-term securities fell sharply. This is extremely dangerous, but theoretically it will not be a problem, if SVB managed to hold these securities to maturity. Unfortunately, or should I say thankfully, the last figurative straw that broke its back was when SVB announced its losses (laughably questionable decision), which led to a torrent of withdrawals and an eventual bank run shortly after.

There are plenty of lessons that can be learnt from this story. A lot of it is related to the intricate details in finance and accounting. But for the everyman, what lessons can we learn from this story which may help us to manage our personal finance better? Where should we put our money? How should we split the dollar? I shall break down my analysis into these broad aspects: the importance of diversification, the importance of choosing the right governments, and the importance of choosing the right institutions.

There are three words that I could not emphasise further whenever I interacted with clients who belonged to the group of rookie investors. Diversify, diversify, DIVERSIFY! I have witnessed countless young adults around me buying stocks without being fully aware of what a stock is. Worse off, without complete awareness of the differences between stocks and bonds, they confidently moved on to options and futures trading. Only the probabilistic few, or “exceptional” few in their view, made money, leaving the vast majority being outright defeated by the market. Not surprisingly, quite a sizable proportion of people of my age who lost a significant share of their investments were also those who did not diversify their assets. 

Hence, before anyone moves on to the A to Z of investing, my only advice is to please first learn diversification. In fact, the A to Z of investing is about diversifying effectively - maximising returns while minimising risks. An easy concept, but make no mistakes, even giants fail. SVB came into this picture perfectly with a grotesque balance sheet and severe lack of diversification. On the liability end, SVB mainly relied on a highly concentrated pool of clients for sources of funds; on the asset end, SVB held a questionably high proportion of long-term fixed income securities. These piled up to a significant level of risk which could have very well been avoided with simple diversification.

You may ask, who are we to judge the decisions of the ex 16th largest consumer bank in the United States (US)? Most of us will not do any better being put in a managerial role in SVB. But remember the central topic of this article is about personal finance. The real question is: if even big banks like SVB can fail due to lack of diversification, who are we individuals to be confident of owning undiversified portfolios? So before you go for a vacation and leave your investments lingering with the market, ask yourself whether your portfolio is really diversified. Do some mini “stress tests” and ask yourself what is the probability of losing 50% of your assets after coming back from a blissful seven day tour in Japan.

The collapse of SVB, also coincidentally Signature Bank, would have very likely sprawled aggressively across the financial markets, leading to a major credit crisis across small to medium banks in the US, for not policyholders came in decisively and professionally to rescue the deposit holders. That brings to my second point: choosing the right governments. In the world of finance, many outcomes are anchored by expectations. Money does not care about morals, politics or ethnicity. As long as there is arbitrage, money moves.

But money does care about expectations. Investors expect and care about expectations. Ordinary citizens expect. One of the major roles of central banks and governments is to manage such expectations, and the best way to do it is through credibility. The policyholders in the US had spent decades building their credibility in maintaining a robust financial system. The Fed and the US government, most of the time, had also been consistently keeping their promises related to economic targets (political promises aside). With the foundation of a large and stable economy, investors panic less, as they expect policyholders to stabilise the spillover effects of the collapse of SVB. This stabilises the market and minimises any unnecessary fluctuations. To draw comparisons, you may visualise, if such a bank run happened in Zimbabwe or Pakistan, how much more catastrophical it would be.

Hence, it is important to pick the right country to invest in. Despite the bankruptcy of SVB, deposit holders were able to get back their money because there was a strong government in place as a second layer of protection. So having a strong government surely helps. My advice to many of my clients, as well as those who are new to investing, is that before you invest in your favourite stock or bond, do take a moment to ponder about the greater macroeconomic aspects. Does the country have a strong credit history? Does the government have an interest in supporting the industry? What is the confidence level that investors have for this country’s economy?

Lastly, picking the right institutions. This is the hard part where even professional investors fail. After all, if it is so easy to know exactly which institutions to put our money in, there will no longer be so many PhDs needed in the finance industry. Nevertheless, we should at least try. But try only after you have diversified your portfolio and chose the right governments. Hindsight is always twenty twenty, but in reality it is not easy to predict such a bank collapse. Yet, there are some telltale signs we can look out for when choosing which institutions to invest in.

Once again, we take the example of SVB collapse. Firstly, there was a lack of astute management. Despite managing billions of assets, SVB lacked a chief risk officer through much of 2022. It is therefore important for us to not only look at the performance of institutions, but also the management team behind it. A strong team with a clear vision of safeguarding shareholder money is definitely not a sufficient, but an often necessary condition for long-term growth and profitability. Secondly, there was too much risk-taking. SVB could have scaled down its purchase of long-term fixed income securities, but they did not. When we invest in institutions, we ought to scrutinise the balance sheets carefully. Whenever there is an alarming rise in a certain type of asset, we should ask ourselves if the level of underlying risk increases drastically as well. Make no mistakes, investors love companies that take risks. Look at Tesla from our (debatably) favourite Elon Musk. But we need to have the basic acumen to hedge ourselves with alternative assets with inverse relationships or with options. Lastly, there was a high client concentration where SVB served a specific group of tech start-ups. Nothing wrong with the strategy, but we also need to understand that it is a double-edged sword. We may want to rethink if we ever intend to put all our eggs in one basket. It will not be so bad if we only put ten cents in SVB for every one dollar we deposit in banks. Ultimately, the gist is to think carefully before we act.

Interestingly, when the collapse of SVB was all over the news, one of my clients questioned me if the same could possibly happen to AIA. My short answer is no. First, we have to look at the unique characteristics of banks. Bank run happens because banks can legally expand their balance sheets for as long as they meet the reserve ratio stipulated by law (the reserve ratio is the percentage of reserve liabilities). Non-banks do not have such superpower, but neither will they get ran over by a bunch of angry depositors. Next, we inspect the differences in the nature of the businesses. Commercial banks hold a large amount of short-term liabilities as deposits but typically conduct long-term investments. This is in contrast with insurance companies such as AIA which almost only hold onto medium to long-term liabilities, as most insurance and investment-linked policy contracts have a long duration. Insurance companies can easily match these long-term liabilities by purchasing long-term assets. To put it simply, if for example, in a hypothetical scenario, AIA was to purchase the exact long-term fixed income securities that SVB did, it is almost impossible that it will collapse simply because AIA can match each and every one of these securities with a policy contract that has similar maturity and cash value. In fact, the company may even gain a lucrative profit from the spread if it holds these securities till maturity, even if short-term fluctuations can significantly affect their prices. So companies that sell insurance and investment plans are quite different from banks after all.

At the end of the day, the story of SVB will be forgotten. So will this article. But if there is one thing I hope you can remember, it is that you should always protect your money just like how the lioness ferociously defends her calves. Do not ever lose your fortune because of a simple, silly mistake. Diversify. Choose the right governments. Pick the right institutions.