Bank regulators have recently witnessed the largest bank failure since the Great Recession with Silicon Valley Bank. Customers were rushing to take their money out, and recent developments have raised concerns for a few other banks. It's Phil here, and in the last 24 hours, we have just witnessed one of the largest bank failures in U.S. history. What makes this so much worse is that once you begin digging deeper, you'll realize that this is a huge blind spot for the entire banking industry. The saying "too big to fail" may be tested again soon.

Let's talk objectively about what's happening, whether your money is safe, how the entire banking system could be vulnerable if people begin to withdraw their money all at the same time, and what you can do about it to make sure you're best protected. Before we start, if you appreciate the information, it helps out tremendously if you subscribe. If you want to stay up-to-date on topics just like this before I'm able to make a full video on them, I have a newsletter below in the description. It's free, and it costs you nothing. Thank you, and let's begin.

Silicon Valley Bank was founded in 1982 and quickly became a prominent lender throughout Silicon Valley, catering almost exclusively to venture capital. Essentially, this became the startup's bank where CEOs and businesses would go for funding. For the last several decades, that worked out incredibly well until recently.

In 2020, when interest rates were reduced to zero, and stimulus measures were put in place, both banks and people were flush with cash, and almost all of that funneled back into the banking system. Banks currently operate on what's called fractional reserve banking. This means that banks are required to keep at least 10 percent of their customers' money available at all times for withdrawals.

Imagine giving me your thousand dollars to hold for safekeeping, and I turn around and give 900 of that to somebody else, who gives 810 to somebody else, and so on. Under this situation, banks hope that enough people give them 1000 dollar deposits so that when the first person wants their money back, they'll have enough cash on hand to process that withdrawal. This allows their customers access to a much larger pool of money, and they're able to earn interest on their deposits. But that also relies on everyone having faith that the system works and not all pulling their money out at the exact same time, which has started to happen.

Normally, banks would have enough capital coming in from a variety of sources to cover customer withdrawals, but in this case, Silicon Valley Bank's customer base was mainly technology companies that have seen significantly less funding. That means their companies are forced to take more money out of the bank to pay for their own expenses. Silicon Valley Bank severely misjudged the size and pace of the Federal Reserve's rate hikes while assuming that the venture capital market would continue to stay strong. That left them in a situation where they locked too much of their money away in one specific asset that yielded too low of a return, and that occurred at the same time their customers began withdrawing more money than they anticipated.

On March 8th, the company announced that they would be selling off a third of their ownership in an effort to raise 2.25 billion dollars. This was done in response to them being forced to take a 1.5 billion dollar loss on a portion of their bond position, which was done to bring enough money back to the bank to be able to continue processing withdrawals. The problem, however, came on March 9th when word got out that the company could potentially be facing insolvency issues, and as a result, their stock price plummeted more than 60 percent.

That made it unlikely that the company would be able to raise additional capital to help plug the losses. The entire situation then devolved into a full-scale panic, with their CEO calling clients to assure them that their money with the bank is safe, while startup founders were advised to pull their money out as soon as possible, just in case.

Overnight on March 10th, Silicon Valley Bank announced that they had failed to raise capital and instead were looking for a buyer, meaning they quite literally ran out of money, had more withdrawals than they had cash on hand, and were looking for anyone who could potentially take them over. Unfortunately, though, that seemed like too little too late because just a few hours after that, Silicon Valley Bank was shut down and closed by regulators with the message that all of the bank's deposits have been transferred to the new bank.

You might be thinking that FDIC insurance exists for a reason, and they should be able to recover up to 250 thousand dollars almost immediately. However, that's another problem here. Anytime you make a deposit within a bank, you're protected by what's called FDIC insurance, which protects up to the first two hundred and fifty thousand dollars you have deposited in the event of a bank failure. This was created after the bank runs of the 1920s Great Depression as a way to incentivize people to re-trust the banking system, and it largely worked.

Over time, FDIC insurance has evolved to become a requirement for any bank that wishes to legally operate in the United States. Fortunately, the system is efficient, and according to the FDIC website, customers can access their money within a few days of the bank's closure. However, the bad news is that only 2.7% of Silicon Valley's bank deposits are FDIC insured, leaving 97.3% of their money unprotected. The fate of this money is uncertain, and if deposits exceed the FDIC limit, the recovery of losses may take several years to complete. Consequently, customers may not recover all of their funds.

Silicon Valley Bank is not just any bank but serves a significant proportion of venture-backed companies in the US. When businesses entrust all or a significant portion of their money to a single institution, they risk being wiped out overnight. These businesses have invested significant resources, saved money, kept it liquid, and spent it wisely. It is disheartening to see their funds reduced to $250,000 overnight. From this perspective, every business that banks with Silicon Valley Bank is going to suffer significantly, particularly since the bank currently holds over $342 billion worth of customer funds.

While startups may not lose all of their money with the bank, recovering the remaining funds could take years. Furthermore, it is uncertain whether the company will have enough capital to stay afloat during the waiting period. For most businesses, a single bank should not hold everything, including payroll and company expenditures. It is a financial risk that companies cannot afford to take, especially if $250,000 is a drop in the bucket compared to what they have saved.

Although it is unlikely, it is possible for any bank to suffer the same fate as Silicon Valley Bank. The bank's niche market of servicing startups, which were funded by venture capital that was drying up, made it challenging to keep the bank afloat. Consequently, very little money was flowing in, while a lot was flowing out. To make matters worse, the majority of the bank's capital was locked away in bonds for the next four years at a low interest rate that had declined in value. While the bank could have waited and absorbed the short-term losses, customers began withdrawing their funds, leaving the bank with no other option but to shut down.

To protect oneself, customers should never keep more than the FDIC-insured amount in any bank, which is typically $250,000 for an individual account. Large institutions that are more diversified and likely to weather financial storms are the better option. Unfortunately, this advice may not help most people because few keep more than $250,000 in cash in any bank. In the long run, it is wise to spread the risk by having multiple accounts with other banks in good standing to fall back on.

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