Silicon Valley bank collapse highlights vulnerability of small banks; Bitcoin BTC price surges above $22.5K

Investors, buoyed by the regulators’ statement, are sending cryptos higher

After a nerve-wracking Thursday and Friday, crypto investors over the weekend took heart from a decision by federal authorities to fully restore all deposits at the failed Silicon Valley Bank (SIVB) and an announcement by Fintech Circle to cover all of its stablecoin USDC reserves.

Bitcoin recently traded at $22,482, up more than 9.3% over the past 24 hours. The largest cryptocurrency had fallen below US$20,000 early Friday (UTC) as SIVB customers withdrew their funds en masse, prompting California’s Department of Financial Protection and Innovation to shut down the institution, a key player in the global tech sector. The SIVB failure is the second largest in US history.

In a joint statement Sunday, U.S. Treasury Secretary Janet L. Yellen, Federal Reserve Board Chairman Jerome H. Powell and FDIC Chairman Martin J. Gruenberg said that after considering the FDIC’s and Federal Reserve’s recommendations and In consultation with US President Joe Biden, SIVB had “approved measures that will allow the FDIC to complete measures in a manner that fully protects all depositors.”

“Today we are taking decisive action to protect the U.S. economy by enhancing public confidence in our banking system,” the statement said.

Mark Connors, head of research at crypto asset manager 3iQ, called the agencies’ actions “on the face of it risk-asset friendly” in a weekly report, though he cautiously noted, “Too many moving parts and M2 [monetary aggregate of currency and coins, savings deposits and shares in mutual money market funds] still contract.”

But Connors added: “The Fed continues to extend its control of the markets.

Ether also gained ground, changing hands at $1,614, up 9.6% from the same time on Saturday. Other major cryptocurrencies, which were hit hard last week as the impact of SIVB’s collapse on the crypto industry became apparent, also rallied over the weekend, with their biggest surge coming on Sunday. APT, the token of Layer 1 protocol Aptos, and ADA, the native crypto of Ethereum rival Cardano, are up more than 13% and 11%, respectively. The CoinDesk Market Index, a measure of overall market performance, fell nearly 10%.

On Saturday, payments technology firm Circle Internet Financial said it will cover “any gap” in the assets backing its USDC stablecoin if it doesn’t receive the entirety of a $3.3 billion cash reserve it has at Silicon Valley Bank holds. In a blog post, Circle said it will “stand behind USDC and will use corporate resources to cover any shortfalls, involving external capital where appropriate.” The stablecoin’s value fell as low as $0.88 prior to the announcement, but is currently trading above $0.99 cents.

US stocks were swept up on concerns over the banking sector, with the tech-heavy Nasdaq and S&P 500 falling 1.8% and 1.4%, respectively. The S&P ended the week down 5%, its worst weekly performance since September 2022. When trading in Asia opened, the Nikkei 225 and Taiwan TSEC 50 indices were slightly lower.

3iQ’s Connors wrote that regulatory measures to protect customer assets would continue a “regulatory game” in the long term, leading to continued consolidation of the banking sector and the acceleration of stablecoin regulation, among other things.

“Result TBD,” Connors wrote.

SIVB collapse shows why small banks are vulnerable

Late last week, Silvergate Bank, a major fiat on- and off-ramp for the crypto market, announced it was engaging in a voluntary liquidation and shutdown, sparking a market panic. Its main competitor Signature was seized by regulators over the weekend.

While SIVB served some crypto companies, it didn’t serve exchanges like Silvergate or Signature.

The Federal Reserve defines SIVB as a large bank (these institutions have over $50 billion in deposits) and Silvergate as a small bank. Some have said that unless the FDIC acts decisively on Monday, contagion would spread throughout the banking sector. Runs on First Republic Bank and other regional players are already beginning.

Basically, this crisis is not about crypto. The performance of technology companies – considered a risky asset – in a high-yield environment played a role, but it wasn’t everything.

It’s about how small banks have fared during the stimulus-heavy Covid. These small banks are not as well known as SIVB, but like Silvergate they specialize in serving an industry or niche.

They are also the ones driving fintechs. Cross River Bank ($9.9 billion in assets) is the financial system behind Coinbase, Stripe, and Affirm. Evolve Bank & Trust (assets $1.3 billion) is the bank behind Wise and Dave.

These small banks like the arrangement because it diversifies their customer base away from the usual local businesses banking with small, regional institutions.

Tech startups that move fast and break things prefer small banks to traditional big banks. There is a belief that rather than having an account with one of America’s largest banks, they would get along and have a more personal, thoughtful experience. But this in turn means that these small banks – which drive fintechs – are too heavily exposed to the technology sector.

Covid, the curve and small banks

In 2020, small banks saw massive cash inflows onto their balance sheets, in part due to fiscal stimulus and the Fed’s asset purchases, which are typically niche-focused. As the impact of Covid on the economy eased, the supply of cash turned to lending and since September 2021 cash growth on small bank balance sheets has turned negative.

Throughout 2022, retail bank lending increased while cash asset growth remained negative.

“Banks are now sitting at pretty much the lowest comfort level with reserves – especially small banks,” Steven Blitz, economist at TS Lombard, wrote in a February note. “[Small banks] are more aggressive in lending and taking on short-term debt to fund themselves.”

Given the size of these institutions and the lack of cash compared to larger banks, Blitz writes that their borrowing has been more aggressive. Additionally, their small size meant they didn’t have the same level of regulation as their larger counterparts.

“Small banks, many of which are private and therefore have no shareholder concerns about the look of borrowing through the discount window, have consistently moved to using the Fed’s discount window facility,” Blitz wrote.

Both Silvergate and SIVB had large advances from FHLBs on their balance sheets.

In Silvergate’s case, 2022 ended with $4.3 billion in FHLB funds on its balance sheet. That number rose dramatically from the $700 million it had at the end of September 2022 because it needed to shore up its liquidity position in the face of rapid withdrawals following the FTX collapse. Days before its collapse, it said the loans had been repaid in full – further eroding its balance sheet.

Withstand spikes in borrowing costs

Borrowing long and borrowing short has always been the model for banks, but an inverted yield curve contradicts it.

An inverted yield curve occurs when short-term interest rates exceed long-term interest rates – an anomaly since lending money should earn a higher interest rate for the lender over the long run.

At the time of writing, the two-year government bond was yielding a full percentage point more than the 10-year. The two-year yield is up 300 basis points to 4.82% in 12 months.

The dramatic rise in borrowing costs for these banks is making life difficult for them, coupled with a very tech-specific flight of deposits, as investors favor short-term high-yield bonds over risky tech and cryptos.

In this environment, startups don’t raise new money and burn what they have to stay afloat.

Silicon Valley Bank identified this as an issue in its mid-quarter update for Q1-23.

FRED data shows the same is happening with these small banks that are powering startup-friendly fintechs.

What will happen if a deal to save SVIB, the mothership of tech startup funding, doesn’t go through? Or if depositors only get 40-50% of their money back? It becomes a tech freezer. Beware of small banks.

“The government has approximately 48 hours to fix what will soon be an irreversible bug,” Pershing Square CEO Bill Ackman tweeted over the weekend. “These withdrawals will deprive local, regional and other banks of liquidity and will initiate the destruction of these important institutions.”

“Already, thousands of the fastest growing, most innovative venture-backed companies in the US will be without payrolls starting next week,” he continued.

Is Ether (ETH), the native cryptocurrency of the Ethereum blockchain and the second largest by market cap, a safe bet? Penn State Dickinson law professor Tonya Evans joined First Mover to discuss. Also, Bitwise Crypto Analyst Ryan Rasmussen shared his reaction to the crypto markets as US payrolls rose by 311,000 in February. And Angelo Calvello, co-founder of Rosetta Analytics, commented on the collapse of crypto-friendly Silvergate Bank.

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