Why Did Silicon Valley Bank Fail?

The failure of Silicon Valley Bank is one of the biggest banking event since 2008's financial crisis. Many have blamed the bank's ESG policies for the failure. We examine what actually transpired the failure of Silicon Valley Bank.

Short Summary of Events

Silicon Valley Bank experienced huge growth between 2019 and 2022, which led to them having a ton of deposits and assets. Although they only kept a small portion of their deposits in cash, most of it was used to buy Treasury bonds and other long-term debts that are considered low-risk, low-return assets.

As the Federal Reserve decided to increase interest rates to combat high inflation, panic started rising among SVB officials. The increase in interest rate caused Silicon Valley Bank's bonds to become riskier investments because investors could now get bonds at higher interest rates. Hence, the value of Silicon Valley Bank's bonds began to decrease.

To make matters worse, some of the bank's clients, especially those in the tech industry, faced financial difficulties and started withdrawing funds from their accounts. To deal with these withdrawals, Silicon Valley Bank sold some of its investments, but that resulted in losses. SVB lost $1.8 billion, this marked the beginning of the end for the bank.

SVB's Bond Assets and Liquidity Issues

SVB purchased long-term bonds and, when it needed cash, sold them at a loss, resulting in a bank run. This may be expressed as follows for those unfamiliar with financial concepts:

• The duration of liabilities/cash obligations is zero. (Every time a bank accepts your money, they create a liability on their books to give you cash when you need it - 0 duration is not 100 percent accurate, as this would imply that 100 percent of customers withdraw today. This is just an illustration.)
• Bond assets with a duration of seven years. (you will obtain future benefits as a result of your investment)
• The rates rise by 4% (your prior investments had a lower interest rate, so their value decreases as people purchase higher-interest securities).
• Financial institutions must adhere to specific liquidity ratios. As the value of their assets and cash on hand decreased, they were in danger of falling below these ratios.

Now, a few possibilities exist.

1. Because your liabilities exceed your assets, you are insolvent (you owe more than you own).
2. You do nothing and hope that the situation will improve, but it appears that interest rates will continue to rise, so it is unlikely that the situation will improve.
3. To fulfill your financial obligations, you sell your assets at a loss.

SVB chose option 3 and incurred a loss, which alarmed customers and caused withdrawals—resulting in a shutdown. The reason the market panicked is that SVB's error appears to be something that others can also make.

Linking ESG practices to SVB's Liquidity Issues

According to an alternative perspective, SVB's liquidity crisis has been linked to its ESG practices. The firm’s policy on diversity, equity, and inclusion, also known as D.E.I., has been blamed by conservatives as a reason for the bank’s failure. The bank’s focus on DEI prioritized social impact in investment decisions. Blaming SVB’s DEI for its liquidity crisis is deeply flawed.

It's important to note that ESG practices do not necessarily lead to lower financial returns. In fact, many studies have shown that companies that prioritize ESG practices can perform better financially in the long run. Therefore, the key is to strike a balance between social impact goals and financial considerations.

SVB's ESG practices

We at 15 Rock performed a bank of evolution calculation of SVB, and we assumed their ESG team's annual run rate was approximately $5 million, but even if we were off by a factor of 10 and it was actually $50 million, that amount would not have been adequate to cover the bank's liabilities (they were trying to raise 1.75B on their capitalization table and 18 billion in the sale of their assets).

When I managed innovation labs, even so-called "moonshots" had a return on investment (ROI) attached to them. Teams must convert their victories into business value or risk being scrutinized. Climate risk is in a precarious position due to the fact that it is not yet obligatory (regulatory risk) and it is difficult to align it with new revenue streams and cost savings. Consequently, climate teams within businesses frequently have demanding responsibilities and devote more time to influence.

During recent tech layoffs, many of the targets we saw were moonshot teams that were unable to demonstrate immediate and relative business value. Similar to how when budgets are tight, and non-essential items are eliminated first, ESG teams may experience the same fate (honestly, we have not seen it yet and instead have seen an uptick in hiring).

Conclusion

SVB’s liquidity issue has little to do with its DEI/ESG strategy. A detailed analysis of SVB’s debt obligations reveals that they improperly managed its duration risk. If I had to speculate, they did not expect the interest rates to rise so quickly.

Nonetheless, ESG-related conversations are intriguing because they contain a larger question. Is ESG an interruption? I believe it is not a distraction, but I observe that many teams are unable to position it properly and become sidetracked.

I lack the data, but I believe that SVB did a substantial amount of work not only in assisting startups but also in promoting sustainability. A few of our clients closely monitored their work to determine whether their community service contributed to a more stable income (we did the study but were not able to share results, although happy to share how we used our platform to quickly model this).

I would love to see more sustainability reports include projects and actions that demonstrate how business value was increased meaningfully. Similar to how many companies calculate the return on investment for sales and trading personnel, climate risk teams should share the value they create. I believe it would not only silence the skeptics but also encourage other companies to invest more heavily in climate risk.

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