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Roula Khalaf, Editor of the FT, selects her favourite stories in this weekly newsletter.
The writer is a general partner at Balderton
What do we have? Where do we have it? How long does it take to get it back? These three questions are foundational to risk management as I learnt from my first boss at Goldman Sachs. On the morning of the run on Silicon Valley Bank a year ago, my training made it nearly inconceivable to me that any of our portfolio companies would answer “all in one place, and we don’t know” to the latter two questions.
All in one place? But what about concentration risk? In the 24 hours after the collapse of SVB, I investigated further. Clearly, there were risk-management issues for some customers, putting too much of their money in SVB or relying on it too heavily for funding. This might have been the result of naivety or cross-selling from SVB. Or simply herding, with companies opting for the default choice of many in the Silicon Valley community.
But it soon became clear that for a meaningful portion of tech start-ups I spoke to, particularly fintechs, SVB had been the most advantageous choice. They relied heavily on SVB because that is where they could obtain banking services most readily. Many small to medium-sized businesses face difficulties raising debt. The 2023 Federal Reserve Small Business Credit Survey shows that the share of loan, line of credit and cash advance applicants that were fully approved rose to only 53 per cent in 2022 from the 46 per cent in 2021 during the pandemic stress — still below the 62 per cent seen in 2019. That is a lot of companies rejected.
This is bad. Western economic growth is predicated on the health and success of SMBs. In the US, they employ 46 per cent of private sector workers. And every big business — from Ford to Disney, SAP to Google — started as a small business. The limited flexibility of our banking system creates a challenge for any SMB. And increasingly bigger banks are not the solution here.
First Republic and SVB were not small banks but there was a reason why some entrepreneur-led tech businesses were banking with them. It is the same reason why farmers often prefer to bank with their local community banks. According to Goldman Sachs, “small banks disproportionately lend to small businesses in the first place because their closer geographic proximity to individual small businesses gives them an informational advantage in gauging the riskiness of those businesses”. The preference of the SMBs suggests this translates into a greater likelihood of funding and on better terms from lenders outside the mega bank ranks.
Simply, the risk management apparatus of the big banks is not designed for SMBs. Would a mega bank risk a regulatory foot fault for a tiny client contributing a de minimis percentage of their revenue? Not many would.
So one obvious solution to the problems of SMBs is bank licences. While the US is often criticised as overbanked, the number of banks has been in sharp decline, falling every year from levels in the 2000s of 8,000 to just over 4,100 in 2022. Going back further, there had been some 14,500 in 1984. Between 2000 and 2008, the Federal Deposit Insurance Corporation issued 1,243 new insured commercial bank charters, an average of 138 a year. Since 2009, the FDIC has issued 86 new insured commercial bank charters.
Prudent regulation is, of course, crucial, but if we want to create more banks focused on serving clients, a less onerous licensing process would help. More banks means a wider spread of risk tolerances, increasing the likelihood of an SMB finding banking services. The rise of challenger banks in the UK has partially filled the gap left by a decline in small business lending and shows the positive impact new entrants can have.
In a world with instant movement of money electronically, there are risks of deposit flight when confidence in banks weakens, as we have seen in New York Community Bank over the last week. The fix, though, is not consolidation, but rather the distribution of risk over more banks, and better readiness to access the Federal Reserve’s support programmes window in a crisis.
Likewise, SMBs need more innovation in the banking sector. The costs stemming from old, non-modular technology are extremely high and need disrupting. Take, for example, poorly designed anti-money laundering solutions that can flag legitimate transactions as suspicious. This can stop legitimate businesses opening bank accounts and lead to pauses in payments or transfers.
We need a system that encourages new business formation and growth acceleration for all SMBs. We need their owners to take business risk — and we should look to remove any unreasonable impediments.
