Why Deposit Insurance Didn’t Help Silicon Valley Bank

The FDIC insures deposits of up to $250,000, but it didn’t help Silicon Valley Bank avoid collapse. Part of the reason is that many depositors had well over the insurance deposit limit amount invested at the bank and so rushed to move funds as perception of risk increased. That meant that deposit insurance didn’t help much to prevent a bank run. However, the unique way that Silicon Valley Bank operated may have introduced risks too, as the recent sell-off in government bonds as the Fed raised rates aggressively hurt the bank’s investments.

How Deposit Insurance Works

Depositors at U.S. banks typically have up to $250,000 of deposits guaranteed by the FDIC. This means that if a bank should ever fail, then depositors will get back $250,000 as soon as possible from the FDIC, typically the next working day.

Now, that doesn’t mean that the remaining deposits will be completely lost, but it depends on the state of the bank’s balance sheet. Historically amounts over $250,000 have received the majority of their funds back, but not all and on a slower timescale as the bank is wound down. Of course, it remains to be seen what actions regulators will take in this case and what the ultimate outcome is for Silicon Valley Bank depositors.

Also, the $250,000 insurance limit can be effectively increased in cases where multiple named individuals are listed as account owners and across different account types at the same bank, leading to greater amounts of aggregate insurance. Also, if you have deposits at different institutions then the $250,000 deposit insurance limit can apply to each individual bank account. Lastly, not all account types are covered and not all financial institutions are covered. The full details from the FDIC are here.

FDIC insurance is intended to help avoid bank runs, but clearly it didn’t work for Silicon Valley Bank.

Why Silicon Valley Bank Was Different

Silicon Valley Bank, as its name might imply, had a clear focus on start-up and tech companies. For example, Roku had approximately $487M of funds at Silicon Valley Bank and Roblox had around $150M per recent investor filings. We’ll learn more in the coming days, but its likely that many start-ups and tech companies had funds at Silicon Valley Bank.

That also likely caused the problem. Start-up companies generally have large cash balances, often in excess of the FDIC limit of $250,000 that they spend over time to fund their quest to achieve product-market fit. That’s somewhat unusual, often retail bank deposits will be well under the $250,000 insurance limit.

Adding to risk, these start-ups are heavily influenced and typically funded by a relatively small and tight-knit group of venture capitalists with a lot of operational engagement with the companies they invest in. If VCs tell start-ups to pull money from Silicon Valley Bank, then these companies will do so, and quickly. The risk was always there, but with Silicon Valley Bank losing money on bond investments as interest rates increased over recent months, VCs started to get nervous.

Still a simple bank run may not be the whole story, research from JP Morgan suggests that Silicon Valley Bank was unique in two ways that created risk. First because of its deposit base, but also because it has seen severe recent losses on its investments in government bonds relative to capital.

We’ll learn more about the outcome of Silicon Valley Bank’s failure in the coming days, weeks and months and any implications for the U.S. banking sector more broadly where fears of similar runs are currently elevated. It appears likely that the unique nature of the bank’s operations, together with recent turbulence in bond markets may have contributed to Silicon Valley Bank’s demise. The bond sell-off is an issue for the banking sector as a whole, but Silicon Valley Bank was also a unique bank in terms of its customer base.