As a startup founder, you’ve worked tirelessly to raise every dollar you need to get your business off the ground. You know the importance of making sound financial decisions and safeguarding your hard-earned money. So it’s understandable that recent news of failing banks, particularly with Silicon Valley Bank (SVB), may have you feeling concerned. In these tumultuous times, it’s critical to understand what’s happening, that the US banking system is not failing, and there are steps you can take to ensure your money is safe and secure.
As a startup founder, what should you know about how banking works?
Failing Banks Break Trust
The entire banking system is built on trust. When you trade the hours of your life for money and then deposit said money into a bank, you’re signaling that you trust their management of your resources. You allow another business the privilege to invest your hard-earned cash in exchange for safety. Your pillowcase is just not as secure as the bank vault, after all!
Banks Invest Your Investments
When you deposit money into a bank, the bank is allowed to use that money to lend to others or invest in other assets. This allows the bank to earn interest on the money they lend out or the assets they invest in. The interest earned is how banks make a profit and stay in business.
Liquidity is the Measure of Strength
Banks must also maintain a certain level of liquidity. Liquidity is a critical concept in banking. It refers to the ability of a bank to meet its financial obligations, especially in paying out deposits to customers who want to withdraw their money.
When a bank has enough liquid assets, it can easily meet the demands of its depositors without having to sell off other assets or borrow money. This is why banks are required to maintain a certain level of liquidity, typically through holding cash reserves and other liquid assets.
If a bank doesn’t have enough liquidity, it can run into trouble. If more people want to withdraw money than the bank has on hand, it may not be able to meet all of those requests.
Confidence is the Currency
One of the key drivers in every financial market is the strength and stability of the banking system. When investors have confidence that their money is safe in banks and that the banking system as a whole is stable and secure, they are more likely to invest in the market. However, when banks and financial institutions start to experience problems or there is a perception that the banking system as a whole is at risk, this can erode confidence and trigger a broader sell-off.
This creates a self-fulfilling prophecy: if enough investors become scared and start selling, the market can start to spiral downward, further eroding confidence and leading to even more selling. This exacerbates the bank’s liquidity problems and ultimately leads to its failure, as we’ve seen in failing banks like Silicon Valley Bank and Signature Bank.
Interest Rates Were the Trigger
Silicon Valley Bank’s recent demise happened as the Fed raised interest rates. A higher federal interest rate leads to a decrease in the value of existing bonds. On March 8, 2023, SVB began hunting for $2.5 billion to “repair a hole in its balance sheet,” and the word got out to depositors. The rest is history.
So what can you do to ensure your money is safe?
Understand the protections in place even for failing banks
First and foremost, it’s important to understand the protections in place for depositors. The Federal Deposit Insurance Corporation (FDIC) insures deposits up to $250,000 per depositor, per bank. This means that if your bank were to fail, your deposits would be insured up to $250,000. It’s important to note that this insurance only applies to deposits and does not cover investments or other financial products.
That’s great for smaller businesses that don’t have much to lose. But what about all the startups in Silicon Valley who had millions of dollars deposited? That question caused a bank run this month. The U.S. government has now stepped in, taking control of two failing banks, and guaranteeing that everyone will get their money back as they sort things out. This protection above FDIC limits isn’t guaranteed for every failing bank in the future, however!
When choosing a bank, do your research.
While it’s obviously not possible to see which banks will become failing banks, look for banks with a strong reputation and a track record of stability. Consider their financial health, their level of liquidity, and their track record of making sound financial decisions. It’s also important to consider the fees associated with the account, the level of customer service provided, and the convenience of the bank’s location and hours of operation.
There Are Two Types of Banks: Tier 1 & Tier 2
Tier 1 Banks
Tier 1 banks, also known as “Big Banks,” are the largest and most financially stable banks in the United States. These banks are typically considered to be systemically important, meaning that their failure could have significant implications for the broader economy. (This also means the U.S. Government is more likely to step in and keep them from ultimate failure).
Several factors qualify a bank to be a Tier 1 bank, including its size, financial stability, and systemic importance.
In the United States, these financial institutions currently enjoy Tier 1 status:
- JPMorgan Chase: With assets of over $3.7 trillion, JPMorgan Chase is the largest bank in the United States and one of the largest banks in the world. The bank operates in more than 100 countries and serves millions of customers around the globe.
- Bank of America: With assets of over $2.7 trillion, Bank of America is one of the largest banks in the United States. The bank provides a wide range of financial services to individuals, businesses, and institutions, including banking, lending, and investment services.
- Wells Fargo: With assets of over $1.9 trillion, Wells Fargo is one of the largest banks in the United States. The bank provides a range of financial services to consumers, small businesses, and large corporations, including banking, lending, and investment services.
- Citigroup: With assets of over $1.6 trillion, Citigroup is one of the largest banks in the United States and operates in more than 160 countries around the world. The bank provides a wide range of financial services, including banking, lending, and investment services.
- Goldman Sachs: With assets of over $1.2 trillion, Goldman Sachs is one of the largest investment banks in the United States. The bank provides a range of financial services to institutional and high-net-worth clients, including investment banking, trading, and asset management services.
- Morgan Stanley: With assets of over $1.1 trillion, Morgan Stanley is another large investment bank that provides a range of financial services to institutional and high-net-worth clients. The bank offers investment banking, trading, and asset management services, among other services.
Tier 2 Banks
Tier 2 banks are typically smaller and less well-known than their Tier 1 counterparts. These banks are often regional or community banks that serve local customers and businesses. While they may not have the same level of national or international reach as Tier 1 banks, they still play an important role in providing financial services to their communities.
Examples of Tier 2 banks in the United States include:
- Fifth Third Bank: With assets of around $207 billion, Fifth Third Bank is one of the largest regional banks in the United States. The bank provides a range of financial services to consumers and businesses in the Midwest and Southeast.
- KeyBank: With assets of around $176 billion, KeyBank is another large regional bank that serves customers in the Midwest, Northeast, and Pacific Northwest. The bank provides a range of financial services, including banking, lending, and investment services.
- Regions Bank: With assets of around $153 billion, Regions Bank is a regional bank that operates in the South, Midwest, and Texas. The bank provides a range of financial services to consumers and businesses, including banking, lending, and investment services.
- Huntington Bancshares: With assets of around $124 billion, Huntington Bancshares is a regional bank that serves customers in the Midwest and East Coast. The bank provides a range of financial services, including banking, lending, and investment services.
These banks may not be as well-capitalized as Tier 1 banks and may have less regulatory oversight. However, they still must comply with federal and state regulations and maintain sufficient levels of capital and liquidity to ensure that they can meet the demands of their customers and investors.
While Tier 2 banks may not have the same level of name recognition as their Tier 1 counterparts, they can still be a good choice for individuals and businesses looking for financial services. These banks often have a strong focus on customer service and may offer more personalized attention than larger banks. In addition, they may have a better understanding of the local market and the needs of their customers, which can make them a valuable partner for businesses looking to grow and expand in their communities.
Why Risky Tier 2 Banks Become Failing Banks
The failing bank in question, Silicon Valley Bank (SVB), traditionally focused on providing banking services to startup companies and other businesses in the technology and innovation sectors. Because of its specialized focus, SVB has a higher concentration of deposits from startup companies than many other banks, which makes it a riskier version of a Tier 2 bank.
Startups are inherently riskier than established businesses, as they are often unproven and may have limited financial resources. Many startups also have high burn rates, meaning that they are spending money faster than they are bringing it in. Because of this, startups may have a higher likelihood of defaulting on their loans or going out of business, which can be problematic for the bank that is holding their deposits.
The Average Bank is Not a Failing Bank
While it’s easy to jump to conclusions or react out of fear, it’s important to realize failing banks like Silicon Valley Bank or Signature Bank are not the norm, even for Tier 2 banks. According to a report from the Wall Street Journal, as of June 2021, approximately 60% of SVB’s deposits came from startups and other high-risk businesses, compared to around 10% at most traditional banks. This high concentration of risky deposits made SVB more vulnerable to losses if a significant number of its startup clients defaulted on their loans, went out of business, or just pulled out in fear.
Conclusion: Stay the Course
When a bank fails, the consequences can be severe. Depositors lose access to their money, and the bank’s assets may be sold off to pay creditors and depositors. You don’t want to be stuck in this situation, but you also don’t want to be the cause of the situation by reacting in fear. You’ve worked hard for every dollar, and you deserve to know that your money is safe and secure, not a casualty of failing banks!
