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Silicon Valley Bank Failure and How DeFi Could Help

Silicon Valley Bank Failure and How DeFi Could Help

Silicon Valley Bank made headlines recently as the second largest and most recent major financial institution to fail. This massive bank was mostly unheard of before, becoming the centerpiece of nearly every financial news story for months. When you look at the collapse of this massive institution, questions start to arise regarding how no one was able to predict these losses. The data has been reviewed and some interesting facts have come to light thanks to the research.

Notably, there aren’t as many similarities between the US largest bank failure, Washington Mutual in 2008, and today’s Silicon Valley Bank failure. In 2008, there was a myriad of new and unknown, and unregistered financial instruments in the market. These financial instruments were designed to enable bankers to take advantage of clients more easily. They offered lax requirements and were often issued to people without them showing any way to repay the loans. In the end, the practices were found to be predatory which is a bit different than what occurred at SVB.

SVB had left analysts puzzled. However, its failure and the causes were known, but no one was able to see the issues coming. Discussing the failure, Fed Chairman Jerome Powell said that he would use the total force of his investigative units to determine what happened. Here’s what is known so far.

Silicon Valley Bank – A Bank for VCs and Startups

SVB broke from the business model of traditional banks to cater to more high-risk clientele. The bank’s location in the world-famous Silicon Valley made it the ideal bank to support the fast-paced business environment of the community. Silicon Valley is home to some of the best-known disruptive tech firms in the world and SVB planned to be the catalyst for the next wave of innovation.

SVB officially entered the market in 1983 with the express goal of catering to the elite class of investors and entrepreneurs within the bay area. The bank had a slew of products geared toward venture capitalists and other high-risk players in the market. This business model was a huge success which caused SVB to grow rapidly. Impressively, SVB was the 16th largest bank in the US by the end of 2022. According to audits, the bank held $209 billion in assets

Missed Warning Bells

Hindsight is 20/20 and bank failures are no different. The sheer size of this bank made it nearly impossible for people to not notice the red flags. However, the bank was sitting on so much liquid capital that it seemed nearly impossible that it would flop. It would take a withdrawal of billions of dollars in a single day to make this happen.

This insane withdrawal spree is exactly what happened which caused the bank to fail in a matter of hours. What is worse is the fact that the bank was so intertwined with other institutions that it caused the entire global economy to falter. Eventually, regulators stepped in to prevent a complete failure of the national economy.

Corporate Mismanagement

The reports seem to point to a track record of gross corporate misconduct and bad management. There are basic requirements that a financial institution the size of SVB is required to meet. One of these requirements is to have a risk management committee. This committee’s entire goal is to review troubling data and determine the best way to avoid a catastrophic failure.

Interestingly, there was little to no risk management at SVB. Reports have shown the firm didn’t even have a Chief Risk Officer. The CRO is a crucial person in the banking business model as they are the ones who communicate directly to the risk management committee. SVB had left the position vacant for the last 8 months as they felt there was no risk.

The CRO is kind of like a lifeguard in that they monitor the bank’s risks to ensure it’s safe. Had SVB not slacked on this position, the bank could have seen that they were overexposed in a variety of ways. However, since they never filled the role, the bank was caught completely by surprise when all its clients went to withdraw funds the same day.

Unrestrained Growth Isn’t Good

Another red flag that had analysts worried from day one, but was ignored, is the sheer speed at which the bank expanded. The bank went from being relatively unknown to ranking in the top 20 in 3 years. This type of growth isn’t regular and should always raise some alarm bells amongst experts.

In the case of SVB, the bank saw its assets 4x in 3 years. This growth was enough to trigger a warning from the Federal Reserve. The group brought up the bank’s insufficient risk management practices way back in 2019. However, the warning was mostly ignored as the bank was sitting on so much capital at the time.

The main reason that it’s not a good thing for banks to expand their operations so quickly is that many other aspects of their business cycle often fall behind. When you have a bank outgrow its compliance and monitoring capabilities, there are always going to be issues emerging.

Too Much Risk Exposure to Succeed

Analysts have also revealed that SVB was too exposed in the market. For example, most of its customer deposits were uninsured. Most bank accounts have some form of FDIC insurance up to $250K to protect against sudden bank runs and collapse nowadays. However, the VC-focused nature of the bank meant that it lacked these protections.

A subsequent report published by Wedbush Securities showed that 97% of the bank’s holdings were uninsured deposits. In comparison, a normal bank would try to keep this number under 30%, and for good reason. When you have many uninsured funds in your bank, you have a lot of speculative clients.

These clients are not going to risk losing their funding for any reason. As such, the slightest sign or warning can cause every client to liquidate their funds. Since your clients know they are risking a complete loss, they are always going to withdraw funds much faster than a traditional bank.

Zoom in to See the Real Risk Exposure

When you examine the data further, it becomes obvious that other factors made the bank susceptible to failure. For one, the bank was industry specific. The bank only worked with tech startups which meant that it was highly dependent on the success of the tech markets. Whenever you have a financial institution that is industry-segment concentrated, it becomes hypersensitive to risks.

Interest Rate Risk Exposure

Another factor that isn’t that obvious but became so after the fact was the bank’s lack of interest rate protections. The bank held massive reserves in long-dated bonds. These bonds are a typical way for banks to hedge risk. However, in this instance, they were a problem.

The thing about bonds is that they lose value quickly when interest rates rise. Sadly, the FED has aggressively raised the rate from last year to combat inflation. Since SVB held around 55% of its reserves in these bonds, there were massive losses that occurred with the interest rate hike. Worst of all, the bank hadn’t planned anyway to hedge against interest rate hikes which left it extra vulnerable.

Customer Panic

Additionally, since the bank catered to wealthy and elite VC capitalists, many clients held massive amounts of funding in the bank’s accounts. These clients made sudden withdrawals on the day the bank failed. These clients are known to have shaky hands and at the first sign of trouble, they move quickly to get out of harm’s way.

Bank Run

The SVB collapse will go down in history for the sheer size of the bank run. In less than a single day, the bank saw clients withdraw $42B in funding. This massive withdrawal left the bank shuttered and with little hope of recovery. It also led to regulators stepping and renewed interest in personal banking options such as DeFi networks.

How DeFi Could Have Helped

There are a couple of ways that DeFi networks could have helped to prevent these losses. When you zoom out and look at the big picture some obvious glaring issues are still not addressed with today’s banking solutions. For one, the banking industry is centralized.

There are a few people at the top that get the best rates and opportunities. From there, the chances for success dwindle as fewer ROIs and features become available to the average client. By the time you get down to the average banker, they aren’t even securing enough APY to keep up with inflation.

DeFi network provides a better solution for many reasons. They leverage blockchain technology which enables them to remain transparent and provide real-time data to the entire network without any costs. Blockchain networks are faster and more efficient than traditional banking solutions. The added transparency results in more confidence from bankers.

Imagine if a banker was able to see the true holdings their bank held. They could review vital details like what they do with your money and how much they make. These factors would make it easy to see the health of your financial institutions. Realistically, the bank has no desire to share this info with their clients. Instead, they prefer to cherry-pick the best data to keep their shareholders happy.

Eliminate the Issues

One of the biggest problems with today’s banking system is the fact they depend on humans for a lot of their core tasks. DeFi banks shift this strategy and instead rely on smart contracts to ensure that all processes are handled efficiently. This structure has a lot of of benefits. For one, it’s far cheaper. Your bank spends lots of money yearly to be staffed. These costs get passed down to you in the form of fees.

DeFi Fees are Lower

DeFi networks are decentralized meaning that there is no central group to collect all the returns. Instead, network participants share the returns. The rewards are distributed automatically by protocols built to run on blockchains called smart contracts. This approach eliminates delays, errors, and human greed.

DeFi networks are already making a splash in the market due to their high ROIs. These networks can pay 20X more than your traditional bank due to their less overhead and added efficiency. For example, the META VAULT DeFi bank pays out savers 10% APY which is far more than any fiat bank offers today.

Sending Money Internationally

One of the biggest areas where you can see the fee discrepancy is in international money transfers. Sending money across the globe has long been a requirement for billions of people daily. However, the systems used to handle this task have not kept up with the times due to centralization and corruption.

There are only a few major remittance firms operating around the globe. They have managed to take control of the market and set rates at an average of 10%. This rate structure is too much and not justified when you look at the bank’s role in the transactions. DeFi networks can transfer money internationally in seconds for pennies.

Permissionless and Borderless

Unlike SVB or any bank, DeFi networks were designed to be borderless. This structure benefits you because it means that these networks support a global community of users. It also means that you can spend your crypto how you like internationally. There has been a lot of concern about the growing amount of censorship in the market. DeFi networks offer permissionless transactions that are complete in seconds.

DeFi is the Right Choice When you examine the failures of SVB it’s easy to see where they went wrong. Today’s bank clients want more accountability from their financial institutions. As such, there has been a steady migration of users from central banking solutions over to DeFi networks. These systems offer better ROIs and are open to anyone who wants to store wealth and generate returns. For these reasons and many more, DeFi networks are set to replace banks in the coming years.

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