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17 Mar 2023

Economy

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Sarah Hall reflects on the collapse of Silicon Valley Bank and its implications for the UK financial services and technology sectors.

The collapse of Silicon Valley Bank (SVB) on 10 March 2023 is the largest banking collapse since the 2008 financial crisis. Bank share prices declined sharply in the immediate aftermath and confidence continues to be dented in the banking sector internationally.

In the UK, the collapse of what was the sixteenth largest bank in the US raises important questions regarding banking regulation and the future financing of the tech sector.

SVB’s UK’s operation was opened in 2012 to provide a range of banking and financial services to the UK technology, venture capital, private equity and life science sectors. The then Chancellor George Osborne welcomed the opening, stressing its vital role in supporting the development of the UK’s tech sector stating, ‘The news that Silicon Valley Bank is launching a full banking service in London is yet more proof that the UK is fast becoming the technology centre of Europe.’

SVB had a distinctive focus on early-stage, typically small technology start-ups that other banks felt were too risky. Since its creation in 1983, it was deeply entwined with the tech community of venture capitalists and tech entrepreneurs in the Bay Area. As the tech sector boomed so did SVB.

Growing demand for online services during the Covid-19 pandemic saw tech firms increase their deposits at SVB. In the US, this growth was further supported by a relaxation in regulations for smaller banks, such as SVB, that had been introduced following the 2008 financial crisis. As deposits grew, SVB focused its investment on US government bonds which are usually seen as one of the least risky forms of investment.

However, these benign conditions changed when the US Federal Reserve, alongside central banks in the UK and EU, began to raise interest rates at the start of 2022, which reduced the value of government bonds. At the same time, confidence in the tech sector, which SVB was unusually heavily exposed to, declined following the end of the pandemic.

As a result, shortly before its collapse, and partly driven by social media stories about the bank’s health, SVB customers began to withdraw their deposits in order to protect their own cashflows. This left SVB needing to sell bonds at falling prices in order to make up for the declines in deposits and it was this combination that ultimately led to its demise as confidence in its business model collapsed.

SVB in the UK was separate from the US bank with its own board. However, depositors in the UK began to withdraw their deposits as confidence in the bank declined. This quickly led to a run on the UK bank. Despite it complying with UK ring-fencing requirements (separating consumer deposits from perceived riskier banking activities), the Bank of England placed the UK subsidiary into insolvency, before transferring it to HSBC for £1 on 13 March 2023 with the aim of preventing further banks following suit.

Two major issues stem from SVB’s collapse in the UK. First, given SVB’s focus on what it termed the ‘innovation economy’, it raises questions as to how the government will finance its new Science and Technology Framework through which aims to ‘cement the UK’s place as a global science and technology superpower by 2030’.

The Framework envisions greater capital being available for UK tech firms with an ‘increased participation from domestic investors’, particularly from defined contribution pension schemes and through changes implemented in response to the Hill Listings Review designed to make the UK a more attractive location to list as compared to the US.

In light of SVB’s collapse, there are clearly advantages in better utilising the UK’s domestic financial services sector in supporting tech firm growth. However, SVB shows the centrality of deep networks between bankers, venture capitalists and tech entrepreneurs in developing a financial ecosystem tailored to the needs of particular economic sectors such as technology. Recent developments such as the choice to list in the US rather than the UK by the UK chip designer Arm suggest that the UK still has a way to go to catch up with the US in this respect.

The second issue posed by SVB’s collapse relates to the future of banking regulation in the UK. As part of the post Brexit financial services Edinburgh Reforms, the Chancellor Jeremy Hunt announced that the government would consult on changing the ring-fencing regulations for UK banks, including proposals to increase the level of deposits needed before ring-fencing requirements come into effect from £25bn to £35bn.

Ring fencing is designed to protect customers by separating deposits from other banking activities that are seen as riskier.

Questions are now being asked about how the move to higher interest rates might make such a change to ring-fencing requirements riskier for customers.

As a result, following SVB’s collapse, important questions remain regarding how the UK can best meet the financing needs of its tech sector domestically. This includes making regulatory decisions that balance consumer risk with international competitiveness in financial services. Crucially, these decisions are being played out in a far less benign interest rate environment than had been the case just over a year ago.

The UK, in common with the US, will also need to consider the risks as well as the opportunities that arise from deep networks between financiers and entrepreneurs that underpinned SVB’s business model. The extent to which these networks can be better managed through more standard banking business models, such as at HSBC, will be an important factor in shaping the future of financing of the tech sector.

By Professor Sarah Hall, Deputy Director, UK in a Changing Europe.

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