Wednesday, March 15, 2023

The Failure of Silicon Valley Bank

A run on Silicon Valley Bank (SVB) late last week — when account holders started withdrawing money, fearful that the bank didn’t have sufficient funds to honor their requests, thus fulfilling their fears that the bank would not have the funds to cover all withdrawals — led to the bank’s collapse, the second largest bank failure in U.S. history according to NBC News.

U.S. regulators stepped in, spending the weekend developing a plan to protect all deposited funds, even those exceeding the $250,000 guaranteed by the Federal Deposit Insurance Corporation (FDIC).

The SVB of last week is no more, replaced by a “bridge bank” with a new CEO:

Silicon Valley Bridge Bank, N.A. is a new bank that is regulated by the Office of the Comptroller of the Currency. Silicon Valley Bridge Bank, N.A. has fully stepped into the shoes of the former Silicon Valley Bank. — Company News, March 14

SVB’s prior management has no bank to manage, only management questions to answer and tarnished reputations to defend.

The demise of this regional bank, which catered to VCs and their startup companies, unleashed debates about the cause of the collapse and whether the government’s move to protect depositors was a “bailout,” a term that became a pejorative following the Great Recession of 2008. Some argue the FDIC ceiling should not have been raised — don’t protect those rich VCs from moral hazard. Some have inferred that the bank’s failure reflected the higher risk of the startup companies it served.

I think both conclusions are unwarranted. From the varied news reports and opinions I’ve read and heard, I’ve concluded the following:

What Triggered the Run?

Probably to minimize risk and adhere to regulatory requirements, SVB invested some of its deposits in long-term U.S. Treasury bonds. As the Federal Reserve raised interest rates to reduce inflation, the lower yields of SVB’s bonds became a liability: investors could buy Treasury bonds at higher yields than those held by SVB. Faced with a threatened downgrade by Moody’s and depositors withdrawing funds, the bank moved to sell $21.4 billion in bonds — taking a loss of $1.8 billion. That spooked the market and accelerated the run to withdraw funds, which the bank simply couldn’t fulfill. Too much, too fast.

The post mortem on the collapse must determine whether SVB understood its increasing vulnerability as the Fed repeatedly raised interest rates. If so, did it assess the probability of a run, perhaps judging it too low to require action? The threat of Moody’s downgrading SVB apparently prompted management to act, but its options were limited, as it was boxed in by the difference in yields between the bonds it held and current rates.

Making this autopsy more interesting, regulations for mid-sized banks like SVB were relaxed by Congress in 2018, with the bank’s CEO, Greg Becker, an outspoken advocate for looser regulations. Would the previous regulations have prevented SVB’s failure? Or identified the vulnerability in time to address it before the bank run and subsequent collapse?

Coincidentally, the CEO exercised options to buy and sell 12,451 shares of the bank on February 27. Daniel Beck, the CFO, sold 2,000 shares the same day. Both transactions were apparently prescheduled under a 10b5-1 insider trading plan, so they may not indicate that the executives anticipated the failure and sought to enrich themselves. Investigations by the SEC and Justice Department will provide more insight and, hopefully, prosecution if warranted.

Saving the Depositors

Addressing the brouhaha over the $250,000 FDIC insurance limit (per customer per account), let’s start by not equating a checking or savings account as an investment. A key element of a bank’s mission is to provide a safe haven for depositors, one less source of financial risk.

Presumably, many of the accounts at SVB were with businesses, many with multi-million dollar cash flows for staff, supplies, finished goods, capital expenditures, etc. Losing these funds because a company’s account balances exceed the FDIC limit would impair company operations, perhaps catastrophically. Increasing the FDIC limit seems a prudent step to protect the companies and all those who support their operations — none guilty of making a reckless investment.

As the FDIC insurance pool is funded by the banks, not taxpayers, it can be considered a cost of doing business, an investment to ensure public confidence in the banking system.

In the few days since SVB’s collapse, I’m reading of an influx of deposits in big banks such as Bank of America and Citibank, reflecting uncertainty about the security of funds held at regional and local banks. For most individuals, the $250,000 FDIC insurance will be sufficient; however, for companies with larger deposits in checking or savings accounts, increasing the limit seems appropriate and consistent with the goal of a secure banking system.

The FDIC was formed by Congress in 1933. Let’s see if the current recalcitrant Congress will move beyond rhetoric to increase insurance coverage and tighten the regulations to address the root causes of SVB’s failure.

Update: March 18, 2023

Apparently no white knight will rescue SVB, as the parent SVB Financial announced it would file for Chapter 11 bankruptcy protection to sell off the assets of the core bank, although not the funds and general partner entities and SVB Securities.

Reuters reported SVB had only $2.2 billion in liquidity, compared to assets of $209 billion at the end of last year. What a fall.

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