In March 2023, Silicon Valley Bank (“SVB”), an American Bank headquartered in Santa Clara, California, collapsed. SVB had experienced significant increase in deposits, a substantial portion of which was invested in low-risk, low-return long term assets. However, the US Federal Reserve raised interest rates in 2022 which caused a decrease in the value of existing bonds and treasury bills. Due to this, SVB incurred about $1.8 billion loss on its bond portfolio. The bank’s inability to meet customer withdrawals due to illiquid long-term investments resulted in a bank run and its subsequent failure. SVB’s customers had large accounts beyond the $250,000 FDIC limit. Therefore, a large portion of SVB’s customers’ deposits were uninsured. The United States government was forced to intervene, and federal regulators took over the bank to protect depositors and minimise disruptions to the financial system. California regulators shut down SVB, forcing SVB Financial Group to file for bankruptcy. First Citizens Bank acquired most of SVB assets, leaving some assets under FDIC receivership.
During the Covid-19 pandemic, the US Federal Reserve reduced the interest rate to near zero per cent to stimulate the economy. This led to an increase in borrowing, which in turn led to inflation. Between 2019 and 2022, startups attracted significant investor funds which were deposited in SVB; and as a result, the bank experienced massive growth during that period. SVB invested the majority of the deposits in treasury bonds and other long-term debts instruments which were low risk and yielded low returns. The bonds issued then were at near zero per cent interest rates as well.
In 2022, the US Federal Reserve increased the interest rate in an attempt to control inflation. New bonds were issued and the value of existing bonds and treasury bills began to decrease. The increased interest rate also caused the cost of borrowing to increase, which resulted in a majority of the bank’s customers being faced with financial troubles and caused them to make withdrawals from their accounts. The major problem the bank had was that it did not have enough cash at hand to accommodate the withdrawals as majority of the deposits were tied up in long-term investments. As a result, the bank was forced to sell some of its investments at a loss. SVB lost about $1.8 billion on its bond portfolio. The bank announced this loss on 8th March 2023 and the next day, the stock of its holding company (SVB Financial Group) crashed at the market opening. This in turn caused panic as the bank’s customers were alarmed that the bank was becoming insolvent. This led to a bank-run. Customers of the bank started to withdraw their deposits, all at the same time in waves. SVB did not have enough liquidity to satisfy all the withdrawals, and this caused the bank to fail. Federal regulators had to take over the bank.
On 10th March 2023, California regulators shut SVB down and placed the bank under the Federal Deposit Insurance Corporation (“FDIC”). The FDIC (an equivalent of our Nigeria Deposit Insurance Corporation – “NDIC”) insures bank deposits up to $250,000 per depositor. Unfortunately, most of the customers of SVB held more than $250,000 in their accounts. Therefore, the surplus amounts were uninsured.
On 17th March 2023, Silicon Valley Bank’s parent company, SVB Financial Group, filed for bankruptcy. And on 26th March, First Citizens Bank bought all of Silicon Valley (Bridge) Bank except for $90 billion of securities and other assets that remained in FDIC receivership.
- Reasons for SVB’s Collapse
While there is no singular reason or cause for the collapse of SVB, the following factors contributed to the collapse of SVB:
- Concentration Risk and Lack of Investment Diversification: Concentration risk is the level of risk in a bank’s portfolio emanating from concentration of investments in a single counterparty, sector, or country.The customers of the SVB were mainly big startups in the technology sector. Startups are a high-risk client base. The bank should have diversified its customer base. Lack of diversification increased the bank’s exposure to risk. SVB invested the bulk of its customers’ deposits in long-term US treasuries and agency mortgage-backed securities. Unfortunately, bonds and treasury values fell as the interest rates increased.
- The Increase of Interest Rates by the US Federal Reserve: In an attempt to control inflation, the Federal Reserve increased interest rates in 2022. As a result, the value of existing bonds dropped, SVB’s bond portfolio started to plummet. SVB would have recovered its capital if it held those bonds until their maturity date. However, it had to sell its investments at a loss in order to accommodate the withdrawals that the bank’s customers were making at the time.
- Poor Asset/liability Management and Matching: Asset/liability management is a form of risk management whereby the investor tries to alleviate the risk of failing to meet its liability obligations by managing assets and cash flow.Asset/liability matching is simply matching specific assets to specific liabilities. That is, turning assets into more liquid investments when a liability is coming due. Due to poor investment decisions, SVB was unable to satisfy a short-term liability (customer withdrawals) while bearing long-term assets. In other words, the life span of SVB’s assets (treasury bonds and other long-term debts) did not match the span of its liabilities (customer deposits). As a result, SVB’s assets and liabilities were mismatched. SVB had a negative gap (more liabilities than assets).
- Loss of Confidence in the Bank: Following the events of 8thMarch 2023 (announcement of SVB’s loss of $1.8 billion on its bond portfolio and consequently, the crash of its stocks in the market), the public panicked. The bank’s customers saw the bank had liquidity issues and were afraid that the bank was failing. This loss of confidence caused the customers of the bank to do a run on the bank.
- Bank Run: This is the major reason why the bank failed. A bank run is when the customers of a bank out of fear of the bank’s solvency, withdraw their deposits at the same time.SVB customers were afraid that the bank was becoming insolvent so they all started to withdraw their deposits at the same time. Unfortunately, the bank did not have enough cash reserve and its assets were tied up in long term investments.
- Cash Reserve Ratio (“CRR”) Rate: This is the percentage of total deposits bank regulators require a bank to have in cash so as to operate risk free. The CRR in the US was set at 0.0%.Banks in the US were not required to have a cash reserve. So, SVB could take almost all its deposits and invest them in long-term securities, which turned out to be a poor investment decision.
- Poor corporate governance and investment decisions:SVB’s collapse was a result of poor corporate governance and poor investment decisions. This is evident in the bank’s failure to replace the Chief Risk Officer of the bank who resigned in April 2022 until January 2023. There was an absence of robust checks and balances within the governance of the Bank which allowed for poor investment decisions (investing deposits in long term treasury bonds).
- Risks of A Similar Occurrence in Nigeria
During the Naira crisis earlier in the year, Fintechs in Nigeria (such as Kuda, Moniepoint, Opay, Palmpay, etc.) experienced a significant growth, with a surge in the volume of transactions on their platforms, quite like SVB. The Naira redesign caused scarcity of cash, making daily operations difficult for many. Banks struggled as customers shifted to digital banking, causing platform overload and transaction delays. However, Fintechs rose to the occasion and saved the day. They were able to handle the demand and effectively manage large volumes of transactions daily.
Due to the concerns that the rise of fintechs could lead to a decline in customer confidence in traditional Nigerian banks, putting these banks at a risk of losing customers and experiencing significant withdrawals of deposits, Nigerian banks have commenced integrating fintech solutions into their operations. An example of this is Wema Bank’s “ALAT by Wema” which won the ‘Overall Best Mobile App at the Nigerian Fintech Awards’ in 2022.
The Nigerian government and the Central Bank of Nigeria (“CBN”) should be careful, to avoid a similar occurrence to what happened to SVB happening to any Nigerian Bank or other financial institutions, particularly Fintechs which bear a closer resemblance to SVB than other traditional banks. Given the current significant rise in deposits and transaction volumes for Fintechs, it is crucial to implement proper regulations and guidelines particularly in terms of concentration risk management, corporate governance, investments and investment risks, to ensure that they operate safely and securely, maintain sufficient capital to absorb potential losses and avoid excessive risk-taking that may endanger both the institution’s stability and the overall financial system of the country.</p
CBN guidelines such as “Prudential Guidelines for Deposit Money Banks in Nigeria”, “Risk Management Framework for Banks and Other Financial Institutions in Nigeria”, “Code of Corporate Governance for Banks in Nigeria”, and “Guidelines on Foreign Exchange Transactions” need to be tailored to the fintech sector as well, and regulators should take measures to ensure compliance.
Nigerian banks are very likely to meet the same doom as SVB if they do not learn from the bank’s mistakes and examine what they can do differently. It is conceded that a bank run is unlikely in Nigeria right now due to the Naira redesign policy of the CBN which resulted in a scarcity of the Naira notes and an increase in mobile and online banking. Nonetheless, it remains crucial to exercise prudence in order to rebuild customers’ confidence in Nigerian banks, thereby averting the possibility of a bank run.
As regards concentration risk in the Nigerian banking sector, CBN’s effort to ensure a sound overall concentration risk management is commendable. In March 2019, the CBN issued “Guidelines on Management of Credit Concentration Risk under the Supervisory Review Process”, which requires financial institutions to evaluate themselves and identify aspects of concentration risks with the aim of taking measures to reduce their exposure to such risks. Nonetheless, Nigerian banks and other financial institutions need to be careful not to focus on a single sector.
Reassuringly, the CRR which ensures that banks have sufficient liquidity and adequate capital buffers is set by CBN at 32.5% and the liquidity ratio is set at 30%. This will ensure that banks have sufficient liquidity to satisfy short-term liabilities such as customer withdrawals. However, there is no limit on the withdrawal of deposits during a bank crisis. Limiting withdrawals of deposits during a crisis will help prevent a bank run. CBN’s cash policy merely limits free withdrawal of deposits up to the withdrawal limit after which there will be a 5 to 10 percent service charge. There should be a limit on withdrawal of deposits in the event of a bank crisis.
Additionally, the NDIC’s insured limit is currently fixed at ₦500,000 for each depositor in insured Deposit Money Banks and Primary Mortgage Banks and ₦200,000 for each depositor in Microfinance Banks. The NDIC claims that this limit is designed to discourage banks and depositors from taking excessive risks. However, ₦500,000 and ₦200,000 limit are inadequate given the current rate of inflation and the devaluation of the Naira. In the USA, insured limit is $250,000. At the current exchange rate of 1 USD to 784.9713 NGN, ₦500,000 is equivalent to $633.38 and ₦200,000 is equivalent to $253.35. If a bank collapses, depositors will lose funds above these caps and will not be adequately compensated as well. The NDIC’s insured limit should be increased to a value that corresponds with the fluctuations in the foreign exchange market.
What happened to SVB can happen to any bank or financial institution in Nigeria. Thus, it is important to understand the collapse of SVB and learn from it. There should be more effective mandatory compliance guidelines and processes aimed at the reduction of banks’ exposure to risks.
The CBN and other regulators should also ensure strict compliance and regularly monitor and evaluate the guidelines to ensure their efficacy in preventing bank failures. Banks should set up reliable and efficient risk management teams that constantly keep their investment decisions in check, ensuring that the bank does not take actions that puts it at risk of failure. Banks should also diversify their funding sources and investments to diminish concentration risk. It is also important that the CBN, banks, other financial institutions and the government collaborate to show and promote transparency in order to restore the public’s confidence in the banking and financial sector, thereby reducing the probability of a bank run. The CBN should establish a regulation that will limit the withdrawal of deposits during a bank crisis, to prevent a bank run.
For further information on this article and area of law,Please contact Oluwabusayo Ayinde at:
P. A. Ajibade & Co., Lagos by
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- Oluwabusayo Ayinde, Associate, Real State & Succession, SPA Ajibade & Co, Lagos, Nigeria.
- Amanda Hetler, ‘Silicon Valley Bank collapse explained: What you need to know’ (Techtarget, 20th April 2023) <https://www.techtarget.com/whatis/feature/Silicon-Valley-Bank-collapse-explained-What-you-need-to-know#:~:text=Word%20spread%20quickly%20on%20social,bank%20run%20was%20Twitter%2Dfueled> accessed 6th June 2023.
- Tisa Canady, ‘How Interest Rate Cuts Affect Consumers’ (Investopedia, 18th March 2022) <https://www.investopedia.com/articles/economics/08/interest-rate-affecting-consumers.asp> accessed 6th June 2023.
- Erin Gobler, ‘What Happened to Silicon Valley Bank?’ (Investopedia, 1st May 2023) <https://www.investopedia.com/what-happened-to-silicon-valley-bank-7368676> accessed 6th June 2023.
- A bank run occurs when the customers of a bank withdraw or call for their deposits all at the same time, out of fear of the bank’s solvency.
- Ibid 3
- Wikipedia, ‘Concentration Risk’ <https://en.wikipedia.org/wiki/Concentration_risk> accessed 6th June 2023.
- Paul Gompers, ‘Silicon Valley Bank’s Focus on Startups Was a Double-Edged Sword’ (Harvard Business Review, 17th March 2023) <https://hbr.org/2023/03/silicon-valley-banks-focus-on-startups-was-a-double-edged-sword> accessed on 6th June 2023.
- Marc L. Ross, ‘Examples of Asset/Liability Management’ (Investopedia, 17th January 2022) <https://www.investopedia.com/articles/investing/041213/examples-assetliability-management.asp> accessed 6th June 2023.
- Joshua Kennon, ‘What Is Asset/Liability Matching?’ (The Balance, 4th March 2021) <https://www.thebalancemoney.com/asset-liability-matching-and-portfolio-management-4115964> accessed 6th June 2023.
- Arun Asset, ‘SVB Bank Collapse: What’s An Asset-Liability Mismatch?’ (Arun Asset, 15th March 2023) <https://arunasset.com/svb-bank-collapse-whats-asset-liability-mismatch/> assessed 6th June 2023.
- Adam Hayes, ‘What Is a Bank Run? Definition, Examples, and How It Works’ (Investopedia, 27th May 2023) <https://www.investopedia.com/terms/b/bankrun.asp#:~:text=A%20bank%20run%20%is%20when,people%20to%20withdraw%20their%20deposits> accessed 6th June 2023.
- CEIC, ‘United States Reserve Requirement Ratio’ <https://www.ceicdata.com/en/indicator/united-states/reserve-requirement-ratio> accessed 6th June 2023.
- Seun Timi-Koleolu & Oasimm Ogunjimi, “Corporate Governance And Startups: Lessons From The Collapse Of The Silicon Valley Bank” (Mondaq, 28th April 2023) <https://www.mondaq.com/nigeria/corporate-governance/1309554/corporate-governance-and-startups-lessons-from-the-collapse-of-the-silicon-valley-bank> accessed 31st August 2023.
- Naira scarcity resulting from the redesign of the Naira notes and poor distribution of the available cash. See “Naira Redesign: Hardship, anger as old, new notes remain elusive “ (Vanguard, 2nd February 2023) <https://www.vanguardngr.com/2023/02/naira-redesign-hardship-anger-as-old-new-notes-remain-elusive/> accessed 31st August 2023.
- Funmilayo Fabunmi, ‘’ Fintech booms as Naira crisis stretches banks’ digital platforms” (Punch, 3rd March 2023) <https://punchng.com/fintech-booms-as-naira-crisis-stretches-banks-digital-platforms/> accessed 26th July 2023.
- Wema Bank, “ALAT By Wema wins Overall Best Mobile App in Nigerian Fintech Awards” (10th November 2022) <https://wemabank.com/alat-by-wema-wins-overall-best-mobile-app-in-nigerian-fintech-awards/> accessed 31st August 2023.
- Ehime Alex, ‘SVB run: Seven major Nigerian banks at risk – Expert’ (ICIR, 17th March 2023) <https://www.icirnigeria.org/svb-run-seven-major-nigerian-banks-at-risk-expert/> assessed 6th June 2023.
- CBN, ‘Monetary Policy Decisions’, <https://www.cbn.gov.ng/monetarypolicy/decisions.asp> accessed 6th June 2023.
- NDIC, ‘Frequently Asked Questions’ <https://ndic.gov.ng/frequently-asked-questions/> accessed 6th June 2023.
- See Exchange Rates UK “Live Nigerian Naira to Dollar Exchange Rate (NGN/USD) Today” <https://www.exchangerates.org.uk/Nigerian-Naira-to-Dollars-currency-conversion-page.html> accessed 26th July 2023.
- Bawo Egbakhumeh, ‘What Nigerian Banks can learn from Silicon Valley Bank’ (The Cable, 3rd May 2023) <https://www.thecable.ng/what-nigerian-banks-can-learn-from-silicon-valley-bank> accessed 6th June 2023