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Silicon Valley Bank had 3 big vulnerabilities

MARY LOUISE KELLY, HOST:

Banking stocks were shaken by the Silicon Valley Bank meltdown. Yesterday, some smaller banks saw their stocks fall by over half. But today, the market seems to have taken a bit of a breather. And so we are going to look at the company at the center of this, now under federal investigation, Silicon Valley Bank. Darian Woods from NPR's podcast The Indicator From Planet Money joins me.

Hey there.

DARIAN WOODS, BYLINE: Hi there.

KELLY: All right, give me the "Cliff Notes" (ph) version. What do we need to know about Silicon Valley Bank?

WOODS: OK. So the company is about 40 years old. It started in the Bay Area in 1983. Its founders saw this gap. They saw that a lot of technology startups were being turned away from traditional banks. So they found this specialty. They serviced tech companies and their founders. And you have names like Roku, Etsy or Shopify. These are all companies that used SVB at some point.

KELLY: Well, all companies that I've heard of - these are household names.

WOODS: They are - and a slew of companies that hope to become household names. And so with this niche, SVP was expanding pretty steadily, both in the U.S. and overseas. But in 2020, with venture capital money just growing and growing, a lot of cheap money around the place, the bank's deposits shot up like a rocket, and that kind of actually sowed the demise last week.

KELLY: Let's stay with that for a second because I would think a lot of new money, a lot of cheap money would be a good thing for a bank.

WOODS: I mean, I would think so, too. But - and to be clear, having a lot of cash is a good thing. But you got to do something with that cash, and you want a little bit of interest. And what you do with the cash brings risk. And that brings me to Silicon Valley Bank's three big vulnerabilities.

KELLY: Three. All right. Let's do the list. What's number one?

WOODS: OK. So number one, it's what SVP did with all those new deposits. It bought bonds and similar assets that matured way out into the future. So these bonds - they go down in value when interest rates rise. And as we know, interest rates have been rising a lot over the last year.

KELLY: Yeah.

WOODS: And to be clear, a lot of other banks do this. They buy bonds. But SVP did this a lot more, and they weren't hedged.

KELLY: What does that mean?

WOODS: So hedged means they - unhedged means that they didn't - they had all their eggs in one basket. They were betting that interest rates would stay low. And there are ways that banks can pretty simply, I guess - I don't know - buy other eggs. There are investment deals that you can make to get higher interest when interest rates are higher. And some commentators are saying that SVB should have done this more.

KELLY: OK. So that's No. 1. What about - I'm hoping you're going to go here next - but the tech sector, the fact that there were all tied up with the tech sector. Is that on your list?

WOODS: Yeah. That - actually No. 2. So the second vulnerability is that the tech sector, you know, was its primary clientele. And this sector is actually really sensitive to interest rates in the same way. So when interest rates go higher, borrowing is harder. And then startups and tech companies find it harder to raise money. They get less deposits in the bank.

KELLY: And No. 3?

WOODS: OK. So the final flaw - that was panicked customers who weren't covered by normal federal deposit insurance. And this is run by the FDIC, the Federal Deposit Insurance Corporation. All the banks pay into this. And the insurance usually covers accounts up to $250,000. But these accounts for startups were often in the millions. So in your average bank, about half of its customers' deposits are covered. But in SVB, only 10% of the value of its accounts were insured. So when a critical mass of the bank's customers felt like something was wrong on Thursday last week, they withdrew over a fifth of the bank's deposits in one day - $42 billion. And so no bank can sustain those kind of withdrawals and led to the authorities taking over the bank on Friday.

KELLY: And there you have it. NPR's Darian Woods from The Indicator podcast. Thanks.

WOODS: Thanks a lot. Transcript provided by NPR, Copyright NPR.

Darian Woods is a reporter and producer for The Indicator from Planet Money. He blends economics, journalism, and an ear for audio to tell stories that explain the global economy. He's reported on the time the world got together and solved a climate crisis, vaccine intellectual property explained through cake baking, and how Kit Kat bars reveal hidden economic forces.