This is a teaching case for business schools drawing on topical issues and debates reported in the FT
On March 10, the Federal Deposit Insurance Corporation moved into Santa Clara, California, headquarters of Silicon Valley Bank, declared it insolvent and took control. It was the second-largest bank failure in US history and was followed the same day by the collapse of Signature Bank (which became the country’s third-largest bank failure). Stock prices of banks around the world have since been falling amid questions of a return to a scenario like the banking crisis in 2008.
Read: Banks are designed to fail — and they do
Banks fund themselves with mostly short-term funding and hold long-maturity assets on their balance sheets. Short-term funding mainly comes from customer accounts (bank deposits) that are liquid in nature and can be withdrawn at any point. But because banks know all customers will not withdraw at once, they can afford to lock those deposits into long-term investments. Managing the mismatch of maturities on their balance sheets is central to what banks do.
When bank depositors, or any other short-term lender, panic about financial viability, they withdraw their deposits in a “bank run”. In the absence of external help, banks will fail to honour those withdrawals, which leads to failures.
What was different this time?
What causes a run on a bank? A perception among customers that the assets in the hand of banks are not worth their book value, that some of these investments did not pay off as expected and the bank could be insolvent. In 2008 these investments were associated with a falling real estate market as mortgages and mortgage-backed securities were not providing the expected return as defaults exploded.
Not this time. While SVB held a large proportion of safe assets (government-issued securities), their safety — the low probability of default — did not completely eliminate the risk of a decrease in value. As interest rates increased quickly in the previous year, the value of fixed-interest-rate assets was declining, leading to a loss for the bank.
The accounting made this case more complicated. As these securities are not under any threat of default, banks are allowed to keep some at book value and hold them until maturity. But you can only keep assets until maturity if you do not suffer a bank run.
SVB was also different because its deposit base was probably the most likely to stage a bank run. First, most of the deposits were over the $250,000 insurance provided by the FDIC. Second, the customers were part of a close community of start-ups and entrepreneurs in Silicon Valley and rumours about the risk of the bank spread faster than normal. As depositors asked for their money, the bank had to sell assets it was hoping to keep until maturity and the losses became apparent. There was no way back.
Were the regulators sleeping? Did they overreact when they woke up?
Every bank failure leads to questions about what could have been done and whether the response was appropriate. Policymakers stepped in quite fast with a two-pronged strategy: a blanket guarantee to all depositors regardless of their balance and the provision of liquidity to banks to manage a potential surge in withdrawal requests. Policymakers were trying to stop the possibility of similar bank runs elsewhere.
What about the role of regulators before the crisis? First, regulation had been weakened in 2018 in particular for small and medium-sized banks, 10 years after the previous financial crisis. That reflected both the fading memory of why the regulation was in place and lobbying by banks to try to reduce the burden. Second, regulators tend to fight past wars and not current ones.
While stress tests and supervision around the world have considered the possibility of another 2008-style crisis, it is very likely that a “bad scenario” of very fast increases in interest rates was not sufficiently considered given a world of low interest rates for decades.
Questions for debate
1. Do we need to live with the idea that banks are fragile and recurrent banking crises will happen, or should we rethink the design of banks? Bank deposits are considered by most as safe and play a fundamental role in the payment system. But do customers fully understand the mechanisms behind deposit insurance limits? And when those limits are lifted during a crisis, are we not questioning the logic of the deposit insurance system?
2. Was this a bailout? Who was the beneficiary of the bailout, if any? Who will bear the cost?
3. Did regulation fail or is this the result of the unmanageable uncertainty that surrounds economic outcomes and financial markets? Where are the obvious places to strengthen the regulatory framework for banks?
4. Is there moral hazard in protecting depositors in such circumstances?
Follow continuing FT coverage: https://www.ft.com/silicon-valley-bank
Antonio Fatás is a professor of economics at Insead