Rising interest rates, million-dollar investment losses, one-day bank withdrawals in the billions, negative cash balances flirting with a billion, bank failures, government rescues. It’s enough to make some business owners feel the heat.
For many companies, it’s business as usual. After all, they didn’t partner with Silicon Valley Bank, Signature Bank or even the recently sold First Republic Bank and neither did any of their vendors. Their money is safe and their businesses profitable. But should the recent bank collapses at least give them pause? Experts say yes.
What happened
In March, Silicon Valley Bank, a $209 billion asset bank headquartered in Santa Clara, Calif. and specializing in venture capital funding for tech startups, sold its government bonds at a $1.8 million loss to remedy its cash flow issue. The news caused a 60% drop in the company’s stock and an unprecedented $42 million in withdrawals in one day. The bank’s balance sheet showed a $958 million negative cash balance.
The U.S. government took over the bank, guaranteeing bank customers access to their deposits, and provided Federal Deposit Insurance Corporation insurance for deposits over $250,000, where typically that amount would be the limit.
At the time, SVB was the second-largest bank to fail in U.S. history after the Washington Mutual collapse of 2008. Shortly afterwards, New York financial regulators closed Signature Bank, which became the third-largest bank failure.
In May, the government closed San Francisco-based First Republic Bank and it was sold to JPMorgan Chase. First Republic is now second to Washington Mutual in the list of largest U.S. bank failures, with assets just above SVB’s at $212 billion.
Contributing factors
The economic climate, rising interest rates, financial risk mismanagement, lack of diversification and social media-induced panic all contributed to the bank failures.
“All the banks were flush with cash after the pandemic,” said Kevin McCormack, associate professor of operations and supply chain management at Northwood University in Midland, Mich. They used that money to purchase government bonds, which are typically safe long-term investments. Rising interest rates, hard times in SVB’s tech customer base and customers withdrawing cash caused a cash flow issue for SVB, and the bank took a $1.8 billion hit on its bond sales and subsequent 60% stock price drop.
The Federal Reserve had issued several warnings to SVB, which had grown at a breakneck pace, quadrupling assets between 2018 and 2021. SVB was not doing enough to ensure funds availability in difficult times, the government said.
SVB’s cash flow issues spread quickly on social media, causing a 60% drop in stock prices and billions of dollars in withdrawals — what is called a “run on the bank,” much like during the Great Depression. Even after the government’s takeover, customer confidence in banks was low, causing withdrawals from large banks like Signature, and later First Republic, which fell to the same fate.
Supplier issues
“Cash flow makes the world run,” McCormack explained, and it’s not flowing too freely these days for anyone. Most businesses have a “float” time between when they spend money on goods or payroll and when the customer pays, he said. With an impending recession, there’s a decrease in demand and companies like General Motors and Ford are delaying delivery and payment on suppliers’ products, which backs up cash flow.
“All the suppliers are suffering,” said McCormack. As the government insures deposits for large banks like SVB, suppliers are wondering what’s going to happen when their medium- or small-sized bank loses cash flow, he said. “We’re not hearing about the dozens of others that are in trouble.” And those smaller banks are unlikely to receive government assistance because their economic footprint is small.
McCormack noted that 90% of suppliers — whether in the automotive, technology, food or another industry — are privately owned businesses with families to feed, and they’re worried about their cash flow, interest rates to borrow money, a recession and possible bank failures. “It’s as bad as I’ve seen it,” he said.
Lessons learned
Should all businesses take note of these bank failures? Absolutely, said McCormack, adding that they should expect more banks to fail, as all banks have bond investments and many are experiencing similar cash flow issues.
“Businesses of all sizes and specialties can find something to take away from this unfortunate series of events,” said Monica Eaton, CEO of Chargebacks911, which helps companies combat post-transactional fraud. Here are some key takeaways:
• Diversify. SVB and the other failed banks had their eggs in one basket and it didn’t serve them well. “The main lesson for any company is that diversification is essential to protect your business financially,” said Eaton. “By diversifying investments, funds and portfolios, businesses can protect their finances and reduce their risk should a financial collapse of this magnitude take place again.”
McCormack also suggested geographical diversification, noting that companies relying on China for supply and trade are at risk because of political issues. Concentrating supply sources and customers in other countries could incur similar risks in the future.
• Anticipate a recession. Whether it’s a soft or hard recession, how high interest rates go, where the U.S. Gross Domestic Product or value of goods and services lands and more are unknowns, but these bank failures clearly indicate an impending economic downturn. “Prepare for the worst by anticipating demand to go lower,” said McCormack. That means curbing spending wherever possible and making conservative business decisions, he said.
• Mitigate financial risk. SVB’s holdings included about $150 billion in uninsured deposits, or deposits over $250,000, and Signature Bank held more than $70 billion such deposits.
“There are approximately $7 trillion of deposits in U.S. banks that are uninsured, which represents 43% of all total deposits in the U.S.,” said Eaton. “Small businesses should do what they can to make sure their deposits at one particular bank don’t exceed $250,000, or that excess dollar figure could be lost should that financial institution collapse. You may end up paying a higher interest rate at one bank compared to another, but you will have peace of mind knowing that investment is insured and protected.”
• Reduce “float” whenever possible. “Work with customers so they can take delivery earlier” and you can get paid earlier, said McCormack. That will reduce “float” and improve cash flow.
• Protect finances. Businesses must have a budget and financial plan that includes current financial risks and incorporates organizational goals, said Eaton. “The collapse of Silicon Valley Bank is a reminder to small businesses to prioritize cash flow management and ensure that they have sufficient liquidity to cover any unexpected costs or losses,” she said. “Small businesses may need to seek additional financing in order to cover any gap in cash flow, such as lines of credit or loans.”
• Know your bank. Do your research on your bank. Find out what it does with your money, said McCormack. Check headlines and industry news to learn as much as you can about your bank’s operations.
