Tech Founders Beware: How Banking Failures Can Impact Your Business and What You Can Do About It
Hey there, tech founders and operators!
In my previous article, I covered Silicon Valley Bank's recent demise and how every startup CEO and CFO should manage the crisis in the immediate term to avoid a delayed crushing impact on their company. In case you missed it, you can catch up here;
The bank run, which has been referred to as the second largest banking failure since 2008 and in the history of the United States, is not isolated; in fact, since the 2008 financial crisis, there have been several high-profile failures of banks and other financial institutions. In response, regulators have created buffers and taken steps to strengthen the banking system and prevent wider economic disruption through bailout programs because banking failures can also have significant macroeconomic consequences and affect taxpayers.
In the case of Silicon Valley Bank, the Federal Reserve and the FDIC took decisive action to protect depositors and prevent wider economic disruption. This involved allowing the FDIC to complete the resolution of Silicon Valley Bank in a manner that fully protects all depositors, while ensuring that losses associated with the resolution of the bank are not borne by taxpayers. Shareholders and certain unsecured debtholders will, however, not be protected, and senior management has been removed.
Bank Bailouts: Banes and Blessings in a wrap
Firstly, bank failures can have ripple effects on the broader economy, leading to a contraction of credit and a reduction in economic activity. This is because banks are key intermediaries in the financial system, and their failure can disrupt the flow of credit to households and businesses, which can in turn lead to bankruptcies and job losses. This can have a negative impact on tax revenues and government spending.
Secondly, when banks fail, taxpayers may be on the hook for the cost of resolving the bank and protecting depositors. This can happen through the Deposit Insurance Fund, which is funded by premiums paid by banks, but if these funds are insufficient, the government may be forced to provide additional funding or guarantees to protect depositors.
Bailouts can prevent wider economic disruption and preserve public confidence in the banking system, which is crucial for maintaining a healthy economy. However, they can also create moral hazard by incentivizing banks to take excessive risks. Additionally, a special assessment on banks, as announced in the joint statement, may result in increased costs for those institutions.
For example, during the 2008 financial crisis, many banks were bailed out by the government, leading to criticism that they were being rewarded for their risky behaviour. This is why it's important to strike a balance between protecting depositors and the broader economy while also ensuring that banks have appropriate incentives to manage risk and avoid excessive risk-taking.
What bank failures mean to you as a startup founder and how to protect your business
The failure of Silicon Valley Bank highlights the importance of sound risk management practices, such as regular stress testing, oversight of corporate governance, and strong internal controls. As a tech founder, it's important to prioritize these practices and work with established banks that have a proven track record of success and sound risk management practices.
Another key takeaway is to work with established banks that have a proven track record of success and sound risk management practices. These banks have experience managing risk and can help you navigate the challenges of the banking industry. You can check a bank's financial health by reviewing its regulatory filings, such as the FDIC's quarterly reports on the bank's financial condition.
Diversify your banking relationships: It is essential to spread your deposits across multiple banks to minimize the risk of losing access to all your funds in case of a bank failure.
Understand your bank's risk profile: Evaluate your bank's lending practices and risk management policies to ensure they align with your company's risk tolerance. You should also monitor your bank's financial health and raise any concerns with its management.
Maintain adequate cash reserves: Keep a sufficient cash reserve to cover unexpected expenses and weather economic downturns. This will ensure you can continue to operate your business without relying on bank loans or credit lines.
In conclusion, the failure of Silicon Valley Bank and the subsequent bailouts highlight the importance of sound risk management practices and diversification. As a tech founder, it's important to be aware of the risks of banking failures and take steps to protect your business. By working with established banks with a proven track record of success and sound risk management practices, and by diversifying your deposits across multiple banks, you can help ensure the long-term success of your business.
But if new startups only work with established banks, what is going to be the market for new banks?
This would mean they’d have paucity of customers or nothing.