The run on Silicon Valley Bank’s (SVB) deposits has forced the hand of US regulators, who have come to the aid of its wealthy clients, in a precedent with far-reaching consequences.
A rise in interest rates generally favors the profitability of banks, except the badly managed ones like the SVB, prized by venture capital funds and their techno shoots.
Let’s dismantle this disordered mechanism.
The wave of tech investment created an influx of deposits at the SVB which, lacking matching loans to balance its balance sheet, parked many of them in long-term US Treasury bonds. Zero credit risk, but huge unmanaged interest rate risk.
In fact, the Fed’s rate hike has sharply reduced the value of bonds. The rise also prompted clients to prefer floating money market rates to the meager return on deposits.
These cash outflows forced the bank to sell bonds at a loss. To rebuild its weakened capital, Goldman Sachs piloted a failed equity issue.
All it took was a volley of tweets to spread panic. Faster clients have taken out billions; the others came up against doors locked by the Federal Deposit Insurance Corporation (FDIC), which took control of the SVB last Friday.
Its rule is clear: deposits are insured up to US$250,000. Except that 96% of them exceed this ceiling at the SVB, an abnormally high proportion.
The weekend was the scene of an intense lobby of venture capitalists, pleading the inability of young shoots to pay salaries. It must be said that the regulators feared a contagion to the other regional banks, which suffered outflows of funds and plunged on the stock market. Moreover, the Signature Bank, the largest lender to crypto speculators, was closed at the same time.
“The SVB depositors are very powerful, very rich and very influential people, carrying a discourse that makes them essential to a vision of the future of America”, explains Adam Tooze, the historian who wrote the reference work on the great financial crisis of 2007-2008.
As early as Monday, President Biden declared that “Americans must be assured that our banking system is safe. Your deposits are safe. However, it is the banking industry and not the taxpayer who will foot the bill, as in previous bailouts.
However, European regulators are furious that their American colleagues have thrown overboard the rules for managing banking crises, reports the FinancialTimes.
In the future, “it will be very difficult to refuse the same treatment to other banks under pressure”, judge the financier Mohamed El-Erian.
According to Larry Summers, former Secretary of the Treasury, “The US government has signaled to all depositors – large and small – that their deposits are safe at all banks. This is a sign that we can no longer trust the discipline of the market, but that we must trust the discipline of the regulations”.
It is probably too much to ask bank customers to check the creditworthiness of their institution. The shareholders must be more attentive, because those of the SVB have lost everything.
At the end of the great financial crisis, we had considerably tightened the capital and liquidity requirements of banks. Regulators had imposed simulations to test their robustness. In the United States, all those with assets greater than 50 billion were subject to it.
But in 2018, under the Trump administration, medium-sized banks were relieved by raising this threshold to 250 billion.
“Since the SVB’s business model poses no systemic risk, imposing the onerous Dodd-Frank requirements designed for the largest banks would be too heavy a burden,” its CEO, Greg Becker, told Congress.
This crisis brings back the pendulum. The Fed is preparing to tighten the framework by lowering the threshold for systemically important banks to 100 billion. The time has come to strengthen the safeguards, pleads the SEC.
The American system is very different from ours with its 5281 banks. Over the past 20 years, more than 500 have gone bankrupt. Canada has only about 30 banks, but the assets are highly concentrated among the six well-known ones, the seven, if we include Desjardins. Since 1996, only an illustrious unknown, the Security Home Mortgage Corporation, has gone bankrupt.
Canadian banks certainly benefited from the liquidity of the Bank of Canada during the 2007-2008 crisis, repaid soon after, but they did not need a capital injection from the government, as in Europe and the United States.
Above all, there was no regulatory relaxation. However, the deposit insurance ceiling set at $100,000 per account since 2005 should be reviewed. Let’s not relax our vigilance, the rise in rates has not finished testing the financial system, witness the concern that is shaking Credit Suisse.