The collapse of Silicon Valley Bank and Signature Bank and the US federal government’s rescue of all depositors through the invocation of a systemic exemption will unleash a lasting torrent of recrimination, introspection and commentary, going well beyond the rescue itself. A plethora of issues will need to be assessed and those set out here will undoubtedly already be on the table.
Outrage that the rescue is a bank bailout and will foment moral hazard are already being loudly heard. Up against bailout criticisms, the Federal Reserve and Treasury will feel compelled to defend their actions, reverting to the standard argument that shareholders will get wiped out and others hurt, so the rescue should not be seen as a bailout. But, of course, uninsured depositors are being protected.
Authorities are quite mindful of moral hazard and the adverse incentives spawned by their actions. But just as has been the case, whether Republicans or Democrats were in power such as in 2008-09, the immediate need to protect the global and/or US economic and financial systems from severe harm and runs is rightly seen as far outweighing moral hazard concerns.
Authorities can focus on corrective actions tomorrow. Today’s job is crisis management and stopping the run.
Already, some analysts are recalibrating views on US monetary policy. An emerging consensus suggests the Fed will no longer consider hiking by 50 basis points in two weeks, but 25bp. Some are even suggesting there will be no hike in March. Yet inflation remains sticky, with some holding to an expected terminal rate above 5.5%. Meanwhile, Treasury rates – especially short-term rates – are plummeting and the yield curve’s inversion has been substantially reduced, largely reflecting a run to safety.
For many years, Fed officials and leading practitioners have stated there should be separation between monetary and financial stability policies. Monetary policy should target the dual mandate, while financial stability should be tackled through sound micro- and macroprudential policy. The tools to implement that division were argued to be largely in place in the wake of the Dodd-Frank Wall Street Reform and Consumer Protection Act and post-2008 financial crisis measures.
To listen to commentators and judging by market action, that view has been seemingly obliterated within a span of 48 hours.
There are key issues for the US regulatory system. Under the US deposit insurance system, depositors are protected up to $250,000. But all SBV and Signature Bank depositors are being protected. Depositors were also heavily protected in the 2008 financial crisis, including money market funds.
SVB was the US’s 16th largest bank. It was not seen as systemic. Yet, the financial contagion spawned by market fears and interconnectedness are obviously systemic. Bear Sterns and Lehman in and of themselves were not seen as systemic, and yet they were. A family fund, Archegos Capital Management, set off huge market ructions last year.
Many US regional banks are enormous in terms of their assets. Legislation put forward in 2018 meant that banks under $250bn – not $50bn – in assets no longer needed to comply with enhanced prudential standards and associated supervisory rigour – stress testing and liquidity, for example.
The US needs to consider whether the thresholds for what counts as systemic are appropriate. History clearly suggests that authorities have persistently underestimated contagion and that a much longer list of banks should be subjected to enhanced prudential standards. Inevitably, there should be an examination of whether tougher capital and liquidity standards are needed, especially for medium-sized and regional banks. The banks will continue their furious lobbying of Capitol Hill against doing so, but this week’s runs should be chastening.
One fallout from SVB is that the concentration of the US banking system may further increase. Depositors in small- and medium-sized or regional banks are undoubtedly asking whether they should rethink their holdings. The largest banks, such as JP Morgan and Citi, will most likely seem safer and more attractive. Their portfolios are diverse. Their capital is stronger. They are too big to fail.
Are on-the-ground regulators up to snuff? Analysts are already pointing to myriad flaws in SVB’s practices, even apart from the concentrated nature of its relationship with the valley’s venture capital and tech firms. Deposits soared at a much-faster-than-average pace. SVB relied enormously on funding from Federal Home Loan Banks. Its long-term bond holdings were relatively large and unhedged. These practices should have been red flags for regulators.
Ahead of the 2008 financial crisis, US regulators missed red flags as well. They didn’t understand the complexity of structured products and risks building up on bank balance sheets.
One can argue that SVB wouldn’t have been so badly hit if not for the Fed rate hiking cycle. But other financial institutions are being impacted and weathering the turbulence.
Bank failures will always happen. But a serious investigation needs to be undertaken on why the regulators missed red flags, whether they were complacent and/or subject to regulatory capture and what needs to be overhauled.
These are but a few issues to be spawned by the aftermath of SVB’s collapse. Undoubtedly, more will follow in the days ahead.
Mark Sobel is US Chair of OMFIF.