Are the Recent US Bank Collapses Indicative of Systemic Failures?

In a series of events that ominously reminded of the 2008 global financial crisis, the world saw the collapse of Silicon Valley Bank (SVB) in northern California followed by Signature Bank in New York – two of the largest bank busts in the last decade and a half. SVB was the second bank, after Silvergate, to collapse within about a week. Others like First Republic, Pacific Western, and Western Alliance also showed severe liquidity pressures and seem to be somehow getting up straight after a big stumble.

The seemingly unforeseen failure of these two large financial institutions and the subsequent fear that some businesses could lose substantial deposits had a lot of business owners concerned about the security of their funds. However, recent actions by the Federal Reserve Board and US Treasury Department have assured that the customers will not lose their deposits.

Established in 1983 and headquartered in Santa Clara, California, SVB was among the biggest supporters of the tech industry. As of 2021, it claimed to bank for around half of all the US venture-backed startups. Apart from tech companies, it also served media companies like Vox Media. Prior to its collapse, SVB held assets worth USD 209b and deposits of USD 175b.

The big question – What led to the collapse of SVB?

SVB leaned on excessive concentration on risky tech startups and was also associated with volatile cryptocurrencies. It had invested heavily in bonds, which typically have an inverse relationship with interest rates. The post-2008 recovery saw lower interest rates in the US, which ensured cheaper loans. Tech VCs invested more money in startups, who in turn trusted banks like SVB with their deposits.

However, through the last year, the US Federal Reserve hiked interest rates necessitated by unprecedented inflationary pressures. From 0.25-0.50% in March 2022, the Fed Funds Rate reached 4.5-4.75% in Feb 2023. Indicating a continuation of this streak, Fed Chair Jerome Powell recently said that the rate might even be raised to 5.75%.

Banks like SVB, flush with additional deposits from Covid-era savings and stimulus money, lapped up fixed-rate long term bonds and other fixed-rate investments like mortgage-backed securities. By the end of 2022, fixed-rate securities made up nearly 60% of SVB’s assets. The consistent interest rate hike saw SVB’s USD 91b portfolio of long-term securities nosedive to just USD 76b at the end of 2022. SVB sold USD 21b worth of securities at a loss of USD 1.8b to ensure liquidity. The bank was also planning to sell USD 2.2b worth of shares to shore up its balance sheet.

A consequent ratings downgrade by Moody’s pushed VCs over the edge and several of them including Founder’s Fund, Union Square Ventures and Coatue Management decided to pull their money out of SVB. In a frenzied run on the bank, customers withdrew USD 42b – about a quarter of its total deposits – in just 24 hours. The regulators finally had to step in and take control of the bank’s assets, effectively shutting it down.

Can this be a Deja vu of the 2008 crisis?

Well, the simple answer is no. In recent days, federal regulators have taken dramatic steps to stabilize financial markets, protect depositors from disaster, and prevent more bank failures. US financial authorities including the Treasury, the Fed, and the Federal Deposit Insurance Corporation (FDIC) launched emergency measures to bolster both deposits and confidence in the banking system after the recent bank failures threatened to trigger a broader financial crisis.

The new Federal Reserve Borrowing (FRB) facility promises to offer loans equivalent to the face value of the bonds that banks hold. This gives banks a significant source of liquidity to rely on in an emergency and should help them meet substantial withdrawal demands with more ease.

Was this debacle already in the making?

The fiasco has raised several questions and, not surprisingly, resulted in some political mudslinging too. Several politicians blame the bipartisan legislation signed in 2018 which eased regulations for all but the largest of banks, including institutions like SVB. This legislation scaled back the Dodd-Frank Act, which lawmakers had passed in 2010 and was designed to increase financial services regulation in a way that would avoid a repeat of the 2008 crisis. Under the 2018 legislative changes, banks with assets less than USD 250b were exempted from the stringent supervision that large banks were subjected to. This also meant bypassing the Capital Stress Test – a forward-looking quantitative evaluation of a bank’s capital that models the impact of a hypothetical macroeconomic recession on its capital ratios. In 2018, lawmakers also eliminated the Volcker Rule, which prohibits using deposits for proprietary trading, especially by smaller institutions. These actions quite literally paved the way that allowed banks like SVB and Signature Bank to take riskier bets at the cost of prudent balance sheet management.

Questions also arise on the role of regulators and supervisors for their inability to spot and intervene as these large regional banks loaded up on risky and volatile tech, crypto, and other assets.

In today’s connected world, global economies and their sectoral performances are intertwined like a grapevine. And it is extremely crucial to gather the learnings from our past and stick to the measures devised to protect us. Maintaining stringent oversight without exceptions is the strongest defence against perpetuating individual errors that predictably spill over into a systemic failure. The failures at Credit Suisse perhaps indicate that the events in the US banking market may already be having global repercussions. It is important to revisit and relearn the lessons of past banking crises and ensure that those responsible for these bank collapses – regulators and bankers alike – also face the hard questions.

Author: Himanshu Dutt

Associate Consultant, Strategy Consulting

Image credit: Andreas Prott