The failure last week of two of the country’s largest banks offers a case study in risk mismanagement, the regulators’ responses, and the unintended consequences of both. The collapse of Silicon Valley Bank (SVB) last Friday and Signature Bank of New York (SBNY) on Sunday offered a glimpse into what can go wrong when a bank fails to prudently manage, or even understand its risk exposure. It also demonstrated regulators’ willingness to interfere with the normal mechanisms of a free-market, capitalistic economy, with a goal of limiting further damage. SVB, with $210 billion in assets became the second-largest bank failure in U.S. history, followed on Sunday by SBNY, the third-largest bank failure with $110 billion in assets.
SVB, headquartered in Santa Clara, CA, and a favorite repository of thousands of tech companies, was taken over by regulators Friday, March 10th after customers withdrew $42 billion from the institution’s coffers. SVB, like most commercial banks, borrowed from depositors through demand deposits such as checking and savings accounts. It also borrowed through time deposits such as certificates of deposit ranging from a few months to a few years. The way most banks make money is by reinvesting those deposits, which are liabilities on their balance sheets, into loans and/or securities such as U.S. Treasury bills, notes, and bonds. In the case of SVB, it also invested in long-term MBS (mortgage-backed securities) issued by FNMA, FHLMC and GNMA.
As interest rates increased rapidly over the past year, SVB’s securities fell in value, offsetting the profits from its lending activities. On March 8th SVB announced a sequence of initiatives to shore up its capital, but upon hearing the news many customers panicked and withdrew their funds the next day. Banks must maintain adequate capital and liquid reserves to meet expected and, in this case, unexpected withdrawal demands. SVB obviously miscalculated its liquidity risk, and now lies in the dust bin of failed institutions. And then there was Signature Bank (SBNY) which in addition to its own securities losses, was heavily involved in the cryptocurrency industry.
Fearing a systemic run, regulators guaranteed all SVB & SBNY deposits on Monday, March 10th. Prior to this decision, depositors could have faced a slight inconvenience or possibly, financial ruin depending on the amount of money they had on deposit. Bank deposits are insured up to $250,000 so anyone with that amount or less is in good shape. However, many SBV & SBNY clients had deposits far in excess of the insured limit with reports indicating 85%-90% of SVB’s deposits being in excess of FDIC limits. In guaranteeing all deposits regulators did not bail out the banks, they bailed out the bank’s customers who chose to ignore FDIC insurance limits.
This is a slippery slope because once that happened, another contractual obligation between borrowers and lenders was broken. Those depositors knew the FDIC limits which were posted on the banks’ front doors, websites, on-line accounts, and monthly statements. Those who ignored the insurance limits did so at their own peril, but as it turned out there was no peril. In reality, many companies would be unable to operate if they had to limit deposits to $250,000 because they have multi-million dollar payrolls and accounts payables. They rely on banking regulators to prudently monitor the banks under their jurisdiction, and in the case of SVB & SBNY it appears the regulators were asleep at the wheel. Prices of bank stocks have dropped, and volatility has increased due to current uncertainties. For example, what impact will this have on small community banks and larger regional banks that may not be too big to fail? Will the Federal Reserve now decide that stabilizing the banking industry is more important than containing inflation? How all this plays out is yet to be seen, but many believe the entire banking industry has effectively been nationalized.
Sam Taylor, CIMA®, AIF®, CRPC®