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Bank runs have been a part of banking history for a long time, and they can have serious consequences for both the bank and its customers. Seeing banks struggle in the news can be worrying, but the right knowledge and strategies can help put your mind at ease.
Note that this is not intended to be financial advice. With that, let’s dive into the ins and outs of what may have happened that caused the collapse of Silicon Valley Bank (SVB), the risks of a bank run, and how to choose the safest banking strategy for your small business.
In this article:
- What is a bank run?
- How likely is a bank run or collapse?
- What happened at Silicon Valley Bank?
- The two types of insurance: FDIC and NCUA
- Which is safer: local, regional, or national big banks?
- Should you use the new services that neo-banks and treasuries are offering?
- What Ken says small business owners should focus on
What is a bank run?
A bank run is a situation where a large number of customers withdraw their deposits from a bank in a short period. This can happen when there is a rumor or concern about the bank's financial stability, leading customers to fear losing their deposits. As customers withdraw their funds, the bank's reserves decrease. This makes it more difficult for the bank to meet its financial obligations, potentially leading to collapse.
Bank runs are usually the result of a loss of faith in the bank. They’re not necessarily indicative of a bank’s actual ability to cover its financial obligations. However, as people withdraw deposits over a short period of time, this creates a situation where the bank can become insolvent, which does have real implications for customers who weren’t able to get all their money out.
How likely is a bank run or failed bank?
Not extremely likely. Although the financial crisis in 2008, followed by the high-profile collapses of Silicon Valley Bank and Signature Bank in 2023 may make it seem like the threat is very high, the likelihood of your bank going under is relatively low. This is especially true for large national banks, which are highly regulated post-2008, and have reserve requirements set by the Federal Reserve (or, the Fed) that are designed to safeguard against another financial crisis. In fact, SVB’s leadership had lobbied to lower the regulations for regional banks (like SVB), which was likely a contributing factor to the severity of the fallout.
For many founders, the possibility of SVB collapsing was not even on the list of the many things they needed to think about and keep track of. There are many more immediate and pressing business risks that founders face, such as ensuring there’s enough cash flow to get employees and vendors paid on time, to worry too much about the unlikely event of a banking crisis. (More insights on how small business owners should approach their banking later.)
What happened at Silicon Valley Bank?
So many things, but we’ll keep it simple. SVB specializes in serving tech companies, especially startups. These companies are inherently unstable, but even more so in 2023’s high interest rate environment. SVB had made some moves during the pandemic low-interest rate environment, which were unsustainable post-rate hikes. Concerns about the bank's financial stability arose, leading some high-profile venture capital firms to withdraw funds and urge their startup companies to do the same. This quickly led to a run on the bank, and it went into “receivership” (ie, the FDIC took over) within a few days.
What happened at SVB is different from what happened during the 2008 financial crisis. In addition, it appears to be a somewhat isolated case, at the time of this writing. SVB’s collapse is likely not going to have implications for the larger banking system, at least partially due to its niche customer base, concentrated in the tech sector.
The two types of insurance: FDIC and NCUA
In the event of a bank run or bank collapse, it’s important to make sure that your deposits are insured by either the Federal Deposit Insurance Corporation (FDIC) or the National Credit Union Administration (NCUA). Both organizations provide insurance on deposits, up to $250,000 per account, per depositor, per institution. The FDIC covers deposits at banks, while the NCUA covers deposits at credit unions.
If you’re in the market for a bank account, be sure to check if the bank account is FDIC or NCUA insured. If you’re already banking somewhere, check your estimated coverage using one of the following calculators:
Which is safer: local, regional, or national big banks?
There’s no good, one-size-fits-all answer to this. The “safety” of a bank depends on its financial strength, the quality of its management, and if it’s insured. Regional and local banks and credit unions may have lower reserves, less financial strength, and fewer resources than larger banks. However, this is only in theory: in practice, many regional and local banks and credit unions are just as stable as big banks.
Should you use the new services that neo-banks and treasuries are offering?
Neobanks and treasuries are offering new banking services that can be convenient and cost-effective for small businesses. Brex and Mercury are two prominent examples of neobanks that offer up to $6 million and $3 million, respectively, of FDIC coverage. They do this by spreading out deposits across several banks.
Remember: neobanks aren’t banks; they run on banks. This means that when you store money with a neobank, you’re actually entrusting them to keep your money at a bank. For example, one of the banks that Brex uses is JP Morgan. So, when you deposit with Brex, some or all of the money may be stored in a JP Morgan account.
If you’re thinking of going with one of these banks, you mainly need to make sure that they have FDIC or NCUA coverage. Ken says that if you really want to do your due diligence, you can find out which banks the neobank uses, and do research on each of those.
However, it’s good to note that even if one of the underlying banks fails, you should still be able to get your money back. In a recent webinar, Erik Zhou, President of Brex Treasury, shared that because all deposits are kept under the FDIC limit, funds would be returned to customers in the event of a bank failure. This process usually takes a few days.
Looking for more information about choosing a digital bank versus a traditional one? Read our guide to bank accounts.
What Ken says small business owners should focus on
Ken stresses that the odds of bank failure are quite low, and that small business owners have more everyday pressing priorities that they need to pay attention to, such as cash flow. In light of this, he notes that first, business owners should first be aware of if their bank has FDIC or NCUA insurance, and if the $250,000 limit covers what they have.
First priority: Have enough capital to run your business
Next, business owners should focus on their financial strategy. In his opinion, your first priority should be to ensure that you have enough capital (likely cash, but not necessarily all cash) to run your business, even in case of an emergency. A good rule of thumb is to have enough in readily available, protected reserves for six months of expenses. Of course, this isn’t always possible; the point is that whatever you have, up to six months in reserves (even if it’s two weeks worth), should be both easy to withdraw and insured.
Second priority: Manage liquidity
Your second priority should be to manage your liquidity. This is related to, but different from, the first priority. “Liquidity” refers to how efficiently and easily an asset can be converted into cash. Cash is the most liquid asset, and tangible assets, such as real estate, are the least liquid.
If you have six or more months of capital, but can't access it because it is tied up in Treasury bills (for example), then that capital is not actually available for your business to use. This can prevent you from running your business efficiently.
Bonus: Optimize for yield
An advanced strategy for more established businesses is to optimize for yield, that is, how much money your unused cash is returning. Most small businesses, especially newer small businesses, won’t need to think much about this one. Ways to optimize for yield include shopping around for bank accounts that have competitive annual percentage yields (APY), as well as exploring more advanced methods that require investing the extra funds. Typically, companies with enough money to engage in such practices have a treasurer (or treasury department) whose job is to optimize for yield.
Again, advanced strategies in optimizing for yield likely won’t be on the table for small businesses, especially new ones. So, just remember that whatever you need to run your business should be fully insured and available to you.