How else to explain the fact that the unrealised losses on Silicon Valley Bank’s liquid securities would have wiped out virtually all of its Tier 1 common equity?
The prudential system, with its built-in failure rates, works well as shown by the fact that 71 banks have failed over the past 10 years, according to the Federal Deposit Insurance Corporation (FDIC). Most of these banks had loan books similar to Silicon Valley Bank (SVB) with assets concentrated in geographical areas and in single industries.
Yellen’s intervention
It is fortunate that SVB is captured by the third leg of the US banking supervision model – the Federal Reserve Board regulation of bank holding companies. In this case, SVB has a holding company called SVB Financial.
US Treasury Secretary Janet Yellen was quick to move on Monday to get the Fed to step in and calm the waters. She approved actions enabling the FDIC to complete its resolution of SVB “in a manner that fully protects all depositors”.
“Depositors will have access to all of their money starting Monday, March 13,” the FDIC said. “No losses associated with the resolution of Silicon Valley Bank will be borne by the taxpayer.”
Strictly speaking, the FDIC should only have been protecting deposits up to $US250,000. But it does not want financial system contagion.
Just because the US tolerates a system that allows regional banks to collapse does not mean it makes sense.
As John Cochrane, also known as the Grumpy Economist, said in a blog at the weekend: “The Dodd Frank act added hundreds of thousands of pages of regulations, and an army of hundreds of regulators.”
“The Fed enacts ‘stress tests’ in case regular regulation fails. How can this massive architecture fail to spot basic duration mismatch and a massive run-prone deposit base?” Cochrane said.
“It’s not hard to fix, either. Banks can quickly enter swap contracts to cheaply alter their exposure to interest rate risk without selling the whole asset portfolio.”
Cochrane says the overall architecture of bank supervision – “allow large leverage and assume regulators will spot risks” – is inherently broken.
“If such good people are working in a system that cannot spot something so simple, the project is hopeless. After all, a portfolio of long-term treasuries is about the safest thing on the planet – unless it is financed by hot money deposits. Why do we have teams of regulators looking over the safest assets on the planet? And failing?”
Slack management
Chris Joye, a columnist with The Australian Financial Review, is another strident critic of the US regulatory failure. He says in an analysis piece on Livewire that it was extraordinary SVB did not hedge its interest rate risks.
He says SVB’s ability to get away with slack management of its balance sheet and not undertake basic risk management “could be partly related to a decision by former president Donald Trump’s administration to lift the threshold for classifying a bank as “systematically important” from $US50 billion to $US250 billion in 2018″.
“Conveniently, SVB only had about $US50 billion in assets in 2018, but by 2022 had exploded to $US200 billion,” Joye says.
“This regulatory change allowed non-systematically important banks in the US to avoid a range of tough liquidity, interest rate hedging, and capital rules that the big banks are subject to (including, technically, speaking either avoiding, or not being as restricted by, tough Liquidity Coverage Ratio and Net Stable Funding Ratio requirements).
“So, SIVB got away with much more lax liquidity requirements. It also avoided having to deduct unrealised losses on its hold-to-maturity assets from its equity capital ratio, which larger, systematically important banks are required to do.”
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