Epistula #2: The Aftermath of SVB
What will rise from the ashes of Silicon Valley Bank? Dan Kimerling shares his predictions for the future post-SVB.
The death of Silicon Valley Bank was traumatic for the start-up ecosystem.
Much ink has been spilled on both the proximate and immediate causes of SVB’s demise. Those causes have been thoroughly covered in the media, so I won’t spend needless time rehashing the reasons for its lethal asset-liability mismatch or the state of regional financial institutions. What is more worthy of discussion? What we are likely to see going forward.
As we look to the future, it is important to thoroughly evaluate SVB’s business model as a whole. Even a cursory understanding of the collapse reveals that it was not what made SVB special – its work with the innovation economy – that led to its demise. Rather, it was deficient leadership and inadequate treasury management that brought the bank down.
While the situation is chaotic in the near term, I believe there will be silver linings in the long run. I predict that the chaos and downfall of SVB will lead to four outcomes:
A much larger and more heterogeneous set of banks and bank offerings for start-ups and VC firms.
A short-term chilling effect on the innovation economy.
An increased emphasis on the importance of treasury management.
A change in regulation.
Let me explain.
Predictions for the Future
A Greater Selection of Banks for Start-ups and VC Firms
SVB’s once-dominant market share is now up for grabs and will be for some time.
Banking start-ups and their financiers is a viable business model for financial institutions, especially when paired with a legacy business that has little innovation-economy exposure. Much of the knowledge of how to do so safely and profitably was locked up inside the senior leadership at SVB. Now those people, and their knowledge, are spreading throughout the banking industry – in the US and abroad.
We are already starting to see HSBC (in the US and UK), Stifel, and Fifth Third Bank rapidly orient themselves to go after the hole that SVB’s implosion created. I would not be surprised if, in the fullness of time, we see a much larger and more heterogeneous set of banks and bank offerings for start-ups and VC firms.
A Chilling Effect on the Innovation Economy
SVB was one of the major bankers of emerging venture fund managers. In a world where it takes six to 18 months for the diffusion of knowledge and talent to occur, who services the emerging manager market in the interim? SVB Capital – SVB’s $9.5B AUM asset-management business, which was a major LP for emerging and established managers alike – faces similar questions.
In our view, the longer this business unit is wrapped up in the bankruptcy proceeding, the less likely the team and business can be sold as a unit and the more disruptive it will be to the ecosystem.
An Increased Emphasis on the Importance of Treasury Management
As fintech nerds, the team at Deciens has long cared about what appears to be an esoteric topic: treasury management.
Understanding its considerable importance is why only one of nineteen Deciens portfolio companies had substantive exposure to SVB at the time of its entering receivership. But, every start-up and investor in start-ups has now been forced to care about the topic. This is good for the start-up ecosystem, ultimately decoupling the risks start-ups, in aggregate, have associated with the safety and soundness of the broader US banking system (though, as with all crises, this lesson will ultimately be forgotten at some point).
Measuring risk well and having good management information systems (MIS) should be table stakes, but these moments of panic show that effective treasury management and MIS are often afterthoughts.
A Change in Regulation
SVB’s dramatic collapse revealed gaps in regulation that we expect to be filled.
The first gap relates to FDIC Rule 370. To summarize, Rule 370 says that only banks with more than two million customers are required to keep an up-to-date and accurate ledger of client accounts on a client-by-client basis. If a bank has under two million customers, summary ledgers suffice. Rule 370, however, does not account for the fact that a bank might have a single “customer” with millions of users – what is known in banking circles as customers with “for the benefit of others” (FBO) accounts. Rippling and Gusto are two examples of SVB FBO customers with millions of users. In a world where the Fed did not step in to backstop SVB’s depositors, the FDIC would have needed to work with Gusto and Rippling to constitute the entire record of depositors who were owed funds. We expect that the FDIC will require all banks that offer FBO services to maintain books and records fundamentally equivalent to those required of Rule 370 financial institutions. The precise impact on the fintech ecosystem is too early to be understood, as it will depend on the specifics of the FDIC’s rules. However, because fintechs are some of the most common users of FBO accounts, rules impacting FBO sponsor banks will invariably create trickle-down impacts, including increasing costs, greater compliance, and more documentation. The uncertainty creates risk in the short term and opportunity in the long run. We are, for example, already seeing Wells Fargo end FBO relationships with everyone but Stripe, PayPal, and Square, partially because of the uncertainty related to the proper documentation for these FBO customers. Conversely, Treasury Prime, part of Fund 2018, is already working to align its roadmap to accommodate what potential rules could look like.
The second gap in regulation that is likely to change involves the thinking around deposits. Traditionally, a customer’s deposits at a financial institution (“non-brokered” deposits) were considered stickier than deposits brought to an FI by another FI (“brokered” deposits). However, the run on SVB was the first bank run in the social media era, with VCs inducing panic on Twitter. In this case, non-brokered deposits fled with alarming speed, while brokered deposits were stickier. Overall, we would expect changes to the way that banks categorize and treat deposits considering anyone can move their deposits with a simple tap of their smartphone rather than visiting their branch and queuing up for a teller.
Our view is that, as a matter of public policy (though not statute), deposits in the US are sacrosanct. Above all, the White House, Fed, Treasury, and FDIC are strongly incentivized to ensure the safety and soundness of the US banking system. We continue to stand by the belief that anything that undermines confidence in the safety of deposits is simply not acceptable.
Failure Is More Than Healthy, It’s Necessary
Our hot take at Deciens is that it is healthy for banks to be able to fail, as long as the consequences fall on equity and debt holders rather than depositors. We are concerned about a world where banks are not allowed to fail – that is a world where there is even less innovation and risk-taking inside of the financial services industry.
Successful innovation should reward those who created and financed it, while unsuccessful innovation should hurt those who backed it. That is the nature of capitalism. This fundamental principle aligns with our values, and we stand firmly against anything that inhibits innovation.
The good news is that, within the fintech ecosystem, SVB was not particularly prominent. During my tenure at the bank, it was evident that its commitment to fintech was merely lip service. Ironically, this turned out to be fortunate for the fintech sector and for Deciens. Had SVB genuinely embraced fintech, our circumstances may have been far more precarious.
SVB may have burned down, chilling the innovation economy for a little while, but there will be significant long-term effects that rise from its ashes: a broader range of banks catering to start-ups and VC firms, an increased emphasis on the importance of treasury management, and necessary changes in regulation.
At Deciens, we look to a bright future and remain resolute in our commitment to fostering innovation, championing risk-taking, and cultivating a financial landscape that duly rewards successful endeavors.
