The Bank Failure Blame Game Who is really responsible for the disappearance of the banks of Silicon Valley?

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On March 10, Silicon Valley Bank (SVB) of Santa Clara, California was shut down by California regulators who appointed the Federal Deposit Insurance Corporation as receiver. The failure took investors, customers and lenders of the banks and the country by surprise. It is the second largest bank failure in US history, behind that of Washington Mutual in 2008.

With the FDIC takeover, the bank reopened the following Monday under the new name, Deposit Insurance National Bank (DINB) of Santa Clara, and took over most of the SVB’s business. Regulators reassured depositors that they would be fully reimbursed and could access their money, pointing out that some lawmakers have expressed outright opposition to a bailout under which losses not covered by the Deposit Insurance Fund FDIC would be covered by assessments of the banking industry itself. Yet with the failure, all SVB shareholders suffered a total loss of their investment.

SVB’s failure was primarily the result of $1.8 billion in market value losses in its large portfolio of US Treasury bonds. The Federal Reserve, after all, had raised rates 4.5 percentage points from a year earlier, rather than its more typical loan quality issues. The SVB had purchased billions of dollars of Treasuries and other longer-dated securities in 2020 and 2021 when interest rates were low, and the market value of those bonds was crushed when rates rose. interest increased in 2022 and early 2023.

While higher Fed rates were the immediate cause of this crash, there was another key factor. SVB’s activities were almost entirely focused on the technology sector, and in particular early venture capital-dependent businesses, including cryptocurrency. SVB has called this sector the innovation economy.

In contrast, most banks are intentionally much more diversified and generally focus on less risky sectors in an effort to mitigate risk. Regulators and rating agencies have long been wary of monoline banks, those that focus on one sector or industry because, by definition, they will lack risk diversification.

In particular, there are fewer possibilities to lend to this sector of innovation since start-up companies financed by venture capital are by definition less creditworthy. This is because they are generally very unprofitable and require large and continuous injections of new funds from their venture capitalists to achieve profitability. The consequence was that SVB lending was only a small percentage of its deposits, just over 40% recently, whereas for banks of a similar size the figure was typically 75% or more.

Here’s the problem: With such weak loan demand, the bank had to consistently invest a relatively large portion of its deposits in US Treasuries and other securities. Consequently, it was ultimately more and fatally vulnerable to the decline in bond values ​​triggered by interest rate hikes. Additionally, and again due to the nature of the industry it focused on, the SVB did not have as stable and well-diversified a deposit base as other institutions. SVB’s sole focus on this sector was to blame for its low loan-to-deposit ratio and vulnerable and business-heavy deposit base.

Inflation that resulted from weakened supply chains from COVID and supply disruptions caused by the war in Ukraine forced the Fed to start raising interest rates in the spring of 2022. With the rise in rates interest, SVB’s bond portfolio plunged in value. By 2023, SVB’s $21 billion bond portfolio was yielding just 1.79%, while the 10-year Treasury yield had risen to 3.9%. And the unrecognized loss from the falling market value of SVB bonds was about to wipe out its capital.

Analysis has shown that if these losses were fully recognized, it could bring SVB’s primary regulatory capital ratio down to the basic financial cushion a bank must have to absorb losses and protect depositors from 12% of assets up to zero. Meanwhile, deposits continued to decline and SVB management grappled with other issues, including, in their own words, expected ever-higher interest rates, [and] public and private markets under pressure. They may indeed have grappled with these issues, but not, it seems, with the speed and urgency warranted given the scale of the problems they faced.

Then came the coup de grace for SVB, the downgrading of the rating agencies. Ratings give potential and existing depositors, lenders and investors confidence that the funds they provide are safe. Just days before SVB went bankrupt, Moodys called the bank to let it know it was considering a rating downgrade. If SVB management hadn’t yet seemed hyper-focused on this issue, Moodys’ call spurred them into action.

They launched a two-part plan. The first consisted in selling 21 billion dollars of securities in order to have cash to meet a deposit made at the bank. It accomplished this on Wednesday March 8, but suffered a loss of $1.8 billion in the process, causing its capital ratio to fall below the regulatory requirement. The second part of the plan was to raise $2.25 billion in new capital from investors. SVB had a preliminary commitment of $500 million to present to Moodys and other potential investors as proof of progress. But the world of its capital needs quickly spread once SVB and the investment bank it had hired, Goldman Sachs, reached out to so many investors seeking capital.

Then the two things that the SVB feared the most happened: a major run on deposits began and the bank was unable to raise the rest of the necessary capital. SVB immediately shifted gears in the precious hours they had left and tried to find an outright buyer for the bank, but given the lack of time and the many uncertainties, this effort failed just as quickly. On Friday, March 10, California regulators closed the bank, wiping out shareholders. Immediately after that, Moodys announced that it had downgraded the bank to default, and S&P followed suit.

The fact that SVB had to act with such desperation meant that it had not undertaken any forecasting and risk planning. It could have hedged its interest rate risk from the outset; he could have obtained emergency sources of funding very early on to deal with this type of situation; and it could even have dismissed or discouraged the accumulation of deposits to avoid this very imbalance.

But SVB did not pursue these preventive moves because such moves are avoided. They are avoided because, like any form of insurance, they are expensive. But in the opinion of conservative banking practitioners, this expenditure is a necessity.

Failure is just the latest example of how we haven’t learned to give risk its due even when it’s illuminated like a flashing neon sign against the dark sky of ensuing catastrophe. Why didn’t rating agencies and regulators act sooner? Any market participant or regulator with a basic ability to read financial statements could have seen the problems with SVB. Still, Moodys’ rating for SVB signaled moderate credit risk until just days before its bankruptcy. As for the regulators, maybe the regulators in the state of California didn’t step in forcefully and soon enough, I guess, because they were inclined to give them the benefit of the doubt. Regulators are not geared towards preventive intervention, but are better equipped to intervene after an institution crosses regulatory capital thresholds.

As for the question that haunts Americans’ minds as to whether failure is the harbinger of more pervasive and systemic national economic problems, the short answer is no. As Moodys highly respected Chief Economist Mark Zandi said, the system is as well capitalized and liquid as it has ever been, [and] the banks that are currently in trouble are far too small to pose a significant threat to the whole system.

Written by Richard Vague.Have you read?The world’s most travel-obsessed countries.The world’s most Twitter-obsessed countries.The world’s most popular luxury brands.The world’s most obsessed with fast food in the world.

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