Digital Banking in the Wake of the 2023 Banking Crisis
- Mar 16, 2023
- Pim Tongchai
- Matt Luckman
The Fall of SVB and Signature Bank
As of Monday, March 13, the largest institutional failures since the financial crisis of 2008 have occurred. Silicon Valley Bank (SVB) was shut down and turned control over to Federal Deposit Insurance Corporation (FDIC) on Friday, March 10, 2023, and Signature Bank on Sunday, March 12, 2023. Both banks have a strong reputation in their respective markets. SVB became the backbone of the startup ecosystem. Their deposits grew rapidly when tech stocks and start-up valuations rose during an era of cheap money when interest rates were low. In light of this, many organizations may indeed need to rethink their strategies for the future. It's always important for organizations to remain vigilant and adaptable in the face of uncertainty, particularly in the rapidly evolving technology and life sciences industries.
Digital Practices for the Future of Banking
The collapse of SVB and Signature Bank highlighted the risks of exposure to manual processes and human error previously observed in the 2008 banking crises. Human error and risk mitigation will always be present, but with forthcoming technological advancements, these challenges can be minimized. The errors made that led to SVB and Signature Bank’s closures, along with technological advancements that may help mitigate a similar situation in the future, include:
- The lead up to the closure of SVB was initiated by a failure to predict:
- Sudden rise in deposits;
- Interest rate hikes; and
- The effects of monetary policy on startup spending.
- SVB and Signature Bank were in compliance with regulatory requirements; however, they deviated from industry averages on the composition of assets held such as assets in cash and assets in fixed-income securities.
- Assets in cash
- Signature Bank – 5% of assets
- SVB – 7% of assets
- Industry average – 13% of assets
- Fixed-income securities
- SVB – 55% of assets
- Industry average – 24% of assets
- SVB and Signature Bank had a narrow base of customers as they focused on banking risky niche industries (start-ups, technology, life sciences and cryptocurrencies). This business model exposed each bank to the broader risk of a bank run if the niche industry were to collapse. For example, Signature Bank reported digital asset-related client deposits reached $16.52 billion, approximately 18.65% of the $88.59 billion total deposits as of December 31, 2022.
- Assets in cash
After this incident, banks should be pressed to mobilize their data and build artificial intelligence (AI) and machine learning models to help forecast changes in interest rates deposits and client spending, as well as predict contagion across multiple banks at similar ratings and strengths. Utilizing existing data to model the impacts of different economic environments will assist bank leaders in data-driven assessments of assets held and how those investments mitigate or further future risk. Additionally, AI and machine learning models can be used to help leaders understand and navigate tail-end risk in a black swan event with unexpected outcomes. While eliminating technological disparities cannot solve all the challenges these institutions face, using data to narrow this gap will better enable them to continue providing clients with the confidence that their assets are protected from predictable risks.
Best Practices Around Digital Banking for Tech Companies
When banks don’t anticipate macroeconomic changes and how the economic environment affects their clients, a client venture capital firm with a portfolio of 50 or even 100 startups is now exposed to a single point of failure if the venture capital firm can’t give startups the liquidity they need. As a result, tech startups need to think more carefully about diversifying where their cash lives. Silicon Valley Bank became so successful among startups and venture capital firms because they were known to accept risky assets in frontier industries. That networking effect creates a social contagion that also contributed to this collapse.
Tech and life sciences startups need to think wisely about how to manage their cash. The following are metrics that may be used to evaluate different banks.
FDIC-insured accounts are bank accounts that are insured by the Federal Deposit Insurance Corporation in the United States; the FDIC protects depositors in case their bank fails. When you deposit money into an FDIC-insured account, your deposits are insured up to $250,000 per depositor, per account ownership category, in case the bank fails. This means the FDIC will step in to reimburse you for your insured deposits, up to the legal limit in the 2023 banking crisis. If you’re a small business with never more than $250,000 in deposits, it won’t be an issue, other than a big inconvenience. In the closure of SVB, around 97% of deposits (by value) were uninsured.
Banks with AAA ratings are typically viewed as very safe and reliable by investors and other stakeholders. AAA-rated banks are likely to have access to capital markets at lower interest rates and may have a competitive advantage over other banks that are rated lower. Moving to these banks will provide companies with more security for clients and organizations.
Multiple Bank Accounts Based on Their Rating and Strength
It is important to consider having accounts at different banks, depending on the complexity of your business, and to diversify and put your money in multiple banks based on their rating and strength to help mitigate financial risks. Considerations include:
- FDIC or National Credit Union Administration (NCUA) Insurance: Ensure that each bank account is FDIC or NCUA insured to protect your deposits up to the legal limit in case the bank fails.
- Credit Ratings: Look for banks that have strong credit ratings from independent rating agencies, such as Moody's or Standard & Poor's. These ratings are based on factors such as the bank's financial stability, liquidity and ability to repay debt.
- Capitalization: Examine the bank's capitalization ratios, which measure its ability to withstand financial stress. A well-capitalized bank is more likely to be able to absorb losses and continue operating even in difficult economic times.
- Reputation: Choose banks with a strong reputation for customer service, stability and trustworthiness. Your organization should be working with banks that have good track records of protecting their customers' deposits and providing reliable services.
By spreading your deposits across multiple banks that meet these criteria, you can help protect your organization against the risk of any one bank's failure, while receiving benefits from diversified banking relationships.
Navigating Banking Uncertainty
At EisnerAmper, we recognize our responsibility to keep you informed on opportunities and pitfalls during times of uncertainty, and to provide you with the knowledge to make the right decisions for your business.
If you have any questions, we'd like to hear from you.
Receive the latest business insights, analysis, and perspectives from EisnerAmper professionals.