By Oscar Perry Abello for NextCity | MARCH 13, 2023
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Focusing on wealthy people and their startup investments is not a sign of good risk management at a bank.
Banking has never been about avoiding risk. It’s about managing risk. For years, especially during an era of near-zero interest rates that lasted about a decade, it appeared Silicon Valley Bank and its ilk were managing risk well. But now it should be clear that focusing mostly on wealthy people and the startups in which they invest is not a sign of good risk management at a bank.
The sudden collapses of Silicon Valley Bank, Silvergate Bank and Signature Bank of New York are the consequence of relying so heavily upon clients with unproven startups, the funds that invest in those startups, and the wealthy people who invest in those funds.
It makes sense for banks to do some amount of business with startups and their investors. In fact, it might be better for society if a much greater number of banks were willing to do business with earlier stage businesses. If that were the case, the struggles hitting the tech sector might have been absorbed more easily across many more institutions instead of falling so squarely on a handful of banks.
But those three banks, and a handful of others now in the hot seat, threw too many of their eggs into the startup basket, including and especially cryptocurrency startups like the (allegedly) fraudulent FTX.
If you bank with a credit union, a more typical community bank, a community development financial institution or even a large bank, your bank is most likely not as reliant on that toxic mix of tech sector startups and their wealthy investors. So you don’t have as much to worry about. Your bank isn’t in the same situation. Probably.
You don’t have to take my word for it — check out your bank’s website, social media or other marketing to see for yourself if it’s been pushing hard to attract startups as clients. Startups aren’t just risky investments. What we’re seeing now is how they can also pose a risk if you rely so heavily on them — as well as startup investors — as depositors.
In other words, one of the reasons Silicon Valley Bank collapsed was because as a bank, it didn’t do business with more communities outside of startups and startup investors (and certain industries with strong social ties to them, like wine). As those clients flourished, the bank flourished, and when things went sour for them, they went sour for the bank.
Most startups aren’t yet generating positive cash flow. Most startups, especially in Silicon Valley, raise cash from angel investors or venture capital funds, which they start spending on salaries and operations until the next round of capital raising. That well of easy money dried up over the past few years due to a combination of the pandemic and, more recently, rising interest rates. But thousands of startups kept burning through cash, drawing down on deposit balances at Silicon Valley Bank.
In the cases of Silvergate Bank or Signature Bank of New York, those banks in particular pushed hard to do business with cryptocurrency exchanges. Some of those firms are also startups with no proven cash flow. But more to the point, cryptocurrency exchanges were withdrawing cash at even higher rates as clients of the exchanges divested from cryptocurrency. Silvergate lost more than two-thirds of its deposits in the fourth quarter of 2022 after cryptocurrencies collapsed.
If Silicon Valley Bank or the other banks had a more diverse deposit base, the evaporation of cryptocurrency exchange deposits or slow burn of startup deposits might have been cushioned by influxes in other sectors or customer segments. But as it was, Silicon Valley Bank’s deposit base started to shrink, though more slowly at first.
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Read the full story at NextCity.org.