Translated from Spanish
For Latin American startups, moving capital has been especially difficult in their home countries. For this reason, they have had to turn to fast-growing banks with a risk-prone investment culture where private capital companies have chosen to deposit their money. However, lax supervision by the banking authorities, as well as imprudent management by less supervised banks, have led to disasters such as that of Silicon Valley Bank. Organizations that fight for better financial ethics see the crisis as an opportunity to improve banking practices, particularly those related to private capital.
By Claudia Ocaranza
“Get your money out of Silicon Valley Bank.” That was the first warning message that Gabriel Marcolongo, founder of the Argentinean startup Inclúyeme, received on Thursday morning, March 9, from one of the investors in his firm, which creates labor markets for people with disabilities in 12 Latin American countries.
But this was not the first warning about Silicon Valley Bank (SVB). Previously, the most critical players in the U.S. financial industry, which has a rapacious capitalist culture and where private capital plays an increasingly large role, had already warned about the bad practices of the bank of choice among entrepreneurs.
A series of errors in the application of legislation by U.S. banking authorities, the negligence of Silicon Valley Bank’s managers in not adjusting strategies as interest rates rose, and the bank’s abysmal crisis management led to the collapse that shook the entrepreneurial ecosystem. And it resonated strongly in Latin America where, until now, this unconventional bank was one of the few options for startups in the region to open accounts in the United States, an almost indispensable requirement to receive investments from private equity funds, such as venture capital.
The pressure exerted by private capital firms looking to raise funds in order to invest in startups, which is riskier than traditional investments, had its effect on SVB’s way of operating, which opted to bet on low interest rates in order to offer more competitive services over caution to protect clients’ money.
In fact, the beginning of the SVB crisis was marked by Founders Fund, a private equity fund led by Peter Thiel, founder of Paypal and founding partner of Palantir, who was among the first to withdraw its money from the bank. Although Thiel said he did not do so because he believed SVB was going to fail,1Pablo Scarpellini, “Peter Thiel, el inversor ultraliberal que desató el colapso bancario del Silicon Valley Bank,” El Mundo, 25 March 2023, www.elmundo.es/loc/celebrities/2023/03/20/6414585721efa0cc0e8b45c7.html. the effect was precisely that the rest of the clients became frightened about their money.
“Many startups, including ours, were on the verge of meltdown,” Marcolongo told Empower. Inclúyeme had 90% of its capital safeguarded in several SVB accounts. Marcolongo’s bank run story — when clients stampede to get their money out — is no different than that of other entrepreneurs who also tried to transfer their funds from SVB.
For Marcolongo, as a Latin American entrepreneur, the effect of SVB’s collapse is more profound, as that bank was one of the few options that facilitated banking access in the United States for Latin American startups, while a traditional bank has stricter, often unattainable requirements for technology startups.
Its agile processes made SVB the favorite bank for Latin American startups, which saw it as an example of entrepreneurship as well as an important player in the growth of technology companies in the United States. Now, for the Latin American startup industry, SVB’s failure has demystified the financial security with which the world viewed the North American country.
Beginning Friday, March 10, money transfers were suspended, uncertainty prevailed, SVB stopped answering clients’ phone calls, and “management was: ‘basically, we are closed,’ that was their communication,” said Marcolongo. According to preliminary investigations by the U.S. Federal Reserve System and the Federal Deposit Insurance Corporation (FDIC), in just 24 hours SVB saw 85% of the money it “safeguarded” leave.2Rubén J. Lapetra, “Así cayó el SVB, la versión oficial: pánico, redes sociales y un clásico de ‘mala praxis,’” La información, 30 March 2023, www.lainformacion.com/mercados-y-bolsas/asi-cayo-silicon-valley-version-oficial-panico-clasico-mala-praxis/2883853.
The panic ended when, on Sunday, March 12, President Joe Biden announced that, through the FDIC, every penny would be paid out to account holders, even those above the insured limit of 250,000 dollars.3Melissa Quinn, “Biden says Americans can ‘rest assured’ banking system is secure after SVB collapse,” CBS News, 13 March 2023, www.cbsnews.com/news/joe-biden-silicon-valley-bank-collapse-watch-live-stream-today-2023-03-13.
“The general feeling in the industry is that it is sad because SVB was a good business partner, it had a lot dedicated to Latin America,” stated Hernán Fernández, managing partner of Angel Ventures, a private equity fund in Mexico. He added that, although what happened leaves certain doubts, confidence is not completely lost, because, as soon as the U.S. government took action, it sent a message of tranquility. “It would have been different if that had happened in Mexico or Argentina,” he said.
Angel Ventures was also a client of SVB; however, according to Fernández, for the private equity funds the fear did not spread as much as among the startups, because “we were not in a capital call, we did not have a lot of money there, and we were within the minimums covered, the 250,000 dollars.”
To understand what happened with SVB and its impacts on Latin American entrepreneurship, it is necessary to go back to 2021. That year, startups experienced a mini-golden age, when they capitalized significantly and then deposited large sums of money in their SVB accounts. That same year, interest rates set by the U.S. Federal Reserve System (Fed) remained low, because, “with low rates, (SVB) had to go looking for yield on so much money. They tied up capital at very low long-term rates (such as government bonds),” Fernández explained.
The Fed gradually raised interest rates, but SVB failed to act accordingly. “When the Fed starts raising rates and the problems begin, what SVB should have done was to refinance. It should have liquidated the positions it had in low rates. The dangerous play was that it didn’t do this and bet that rates were going to go down. As they went up, with low yields, by the time the bank wanted to rectify things, it was too late,” said the co-founder of Angel Ventures.
In addition to this landscape, 2023 has not been such a favorable year for startups. They have received less money and have begun to spend those savings deposited at SVB. In other words, the bank began to see its reserves empty.
While, in addition to Treasury bonds — which are insured —, according to S&P Global Market Intelligence, Silicon Valley Bank had uninsured deposits across 94% of its total assets. In other words, SVB surpassed the national average for uninsured bank deposits of 45% in 2022, as reported by Axis Business.4Greg lp, “La confusión generada por SVB tira a la basura lecciones de crisis financiera global,” Axis Negocios, 29 March 2023, www.axisnegocios.com/articulo.phtml?id=118094.
For Marcolongo, the perfect storm that ended up putting the capital of his venture at risk also means a setback in now having to look for alternatives, which affects the operation of his Argentina-based business.
“The step backwards is having to worry more about how do I focus on taking care of and protecting what we have? How do I safeguard that instead of focusing on the operation? I want to focus on people with disabilities having jobs,” he said.
On the other hand, public policy advocacy groups and Democratic lawyers also raised alarms five years ago when Republican Senator Mike Crapo, then head of the U.S. Senate Banking Committee, introduced a banking reform that included lowering capital requirements for some mid-sized banks.
According to USA Today, that reform was contrary to the Dodd-Frank law, which was passed in 2010 and served to prevent “excessive risk” that led to the 2008 financial crisis. With Crapo’s law, Silicon Valley Bank, among others, was left with less oversight.5Swapna Venugopal Ramaswamy, “It’s a wake up call: Advocacy groups, lawmakers highlight law they say led to SVB collapse,” USA Today, 14 March 2023, www.usatoday.com/story/money/personalfinance/real-estate/2023/03/14/repeal-law-led-bank-silicon-valley-collapse/11466071002.
Today, private capital and banking are mutually dependent and, in situations such as SVB’s, their future in capitalism hangs in the balance.6Runaway Train: The Perilous and Pernicious Path of Private Capital Worldwide, Empower, July 2021, Page 44, empowerllc.net/wp-content/uploads/2022/08/Reporte_APE_FINAL_PublicVersion_web.pdf. Sources consulted by Empower clarify that, although the panic was stopped in time, it is an opportunity to question the dynamics with which private capital moves through the financial system, with risky investments and using a “reckless” banking industry.
For Leticia Armenta, research economist and professor at the Tec de Monterrey, both the regulatory authorities of California — where SVB is located —, as well as the Fed and SVB’s internal regulatory authorities, relaxed their systems in favor of the dynamism that startup-driven technological innovation needs.
“In addition to federal regulation, in the United States each state has its own. Regulation becomes more complex than ours [in Mexico]. On the other hand, the fact of wanting to promote technological innovation leads regulators to establish different metrics. In the particular case of SVB, there was a lack of tight regulation so that when more resources were sought, the limit would not be reached. The SVB’s internal authorities should definitely have reacted much earlier, not to let these levels pass, but to anticipate them,” she told Empower.
However, for Carmen Ponce, an economist at Escuela Superior de Economía at the Instituto Politécnico Nacional who specializes in gender issues, although the SVB crisis was stopped relatively early, she emphasizes that some entities “play around with financial speculation and not with a real scenario. There is a real possibility of financial crisis. From the banks it moves to the day-to-day economy,” she commented in an interview with Empower.
On March 27, First Citizen, the bank that acquired SVB, sent an e-mail to SVB’s customers, including Marcolongo. In the communication First Citizen announced its intention to regain the trust of affected customers.
For its part, Americans for Financial Reform, a non-profit coalition working to create an ethical financial system, issued a letter to regulators calling for a “comprehensive and independent investigation of the Fed’s failures in the banking crisis.”7“Letter to Regulators: Silicon Valley Bank Failure Demonstrate the Need to Implement Key Executive Pay Rule, Dodd-Frank Section 956,” Americans for Financial Reform, 28 March 2023, ourfinancialsecurity.org/2023/03/letter-to-regulators-silicon-valley-bank-failure-demonstrates-the-need-to-implement-key-executive-pay-rule-dodd-frank-section-956. The full results of the Fed and FDIC investigation will be made public before May, but, for the organization, the failure of SVB demonstrates the need to re-implement some provisions of the Dodd-Frank Act.
Until these issues are resolved in the U.S., the outlook for startups, especially Latin American tech startups, is bleak. According to René Lankenau, founder of whitepapermx, a newsletter aimed at the entrepreneurial community, “it’s worrisome for the Mexican ecosystem. There are other digital possibilities, fintechs, but they are not banks, they use banking licenses from other entities. And they are small. They don’t have the depth of services needed for startups.”
According to the experts and entrepreneurs interviewed by Empower, the long-term effect of the collapse of SVB in Mexico and Latin America remains to be seen. However, while regulations, legislation, and penalties are being reviewed in the United States, the question arises as to how to prevent the risk, which characterizes private capital, from becoming the door to imprudent management by banks that want to occupy the void left by SVB.
1 Pablo Scarpellini, “Peter Thiel, el inversor ultraliberal que desató el colapso bancario del Silicon Valley Bank,” El Mundo, 25 March 2023, www.elmundo.es/loc/celebrities/2023/03/20/6414585721efa0cc0e8b45c7.html.
2 Rubén J. Lapetra, “Así cayó el SVB, la versión oficial: pánico, redes sociales y un clásico de ‘mala praxis,’” La información, 30 March 2023, www.lainformacion.com/mercados-y-bolsas/asi-cayo-silicon-valley-version-oficial-panico-clasico-mala-praxis/2883853.
3 Melissa Quinn, “Biden says Americans can ‘rest assured’ banking system is secure after SVB collapse,” CBS News, 13 March 2023, www.cbsnews.com/news/joe-biden-silicon-valley-bank-collapse-watch-live-stream-today-2023-03-13.
4 Greg lp, “La confusión generada por SVB tira a la basura lecciones de crisis financiera global,” Axis Negocios, 29 March 2023, www.axisnegocios.com/articulo.phtml?id=118094.
5 Swapna Venugopal Ramaswamy, “It’s a wake up call: Advocacy groups, lawmakers highlight law they say led to SVB collapse,” USA Today, 14 March 2023, www.usatoday.com/story/money/personalfinance/real-estate/2023/03/14/repeal-law-led-bank-silicon-valley-collapse/11466071002.
6 Runaway Train: The Perilous and Pernicious Path of Private Capital Worldwide, Empower, July 2021, Page 44, empowerllc.net/wp-content/uploads/2022/08/Reporte_APE_FINAL_PublicVersion_web.pdf.
7 “Letter to Regulators: Silicon Valley Bank Failure Demonstrate the Need to Implement Key Executive Pay Rule, Dodd-Frank Section 956,” Americans for Financial Reform, 28 March 2023, ourfinancialsecurity.org/2023/03/letter-to-regulators-silicon-valley-bank-failure-demonstrates-the-need-to-implement-key-executive-pay-rule-dodd-frank-section-956.