I'm already tired of Silicon Valley Bank, but I have a question: If the 2018 deregulation bill hadn't passed, how precisely would this have affected SVB? And I do mean precisely. Would they have been required to diversify their deposit base? Would they have been required to hold more capital? Would they have been forbidden from loading up on long-dated Treasurys? Would they have been subjected to stress tests that included huge spikes in interest rates?
What exactly would have been different under the old rules?
They would have been forced to recognize their losses at the next report, rather than being allowed to sit on that huge pile of underwater bonds and marking them “hold to maturity”. This would have forced them to deal with the losses as they came instead building up a dangerous problem that could explode later (i.e., last week).
onemerlin - respectfully I believe you are incorrect. Assets are allowed, even under the Dodd Frank bill, to be valued based on a hold to maturity concept. The requirement to market to market, for everything, is not an element of Dodd Frank....
Agreed - it is not per se the hold to maturity, it is the liquidity risk issue - not per se that they were hold-to-maturity, but in overall context, so under liquidity stress testing the ratio should have been flagged as problematic
Lounsbury - I concur with your analysis, the challenge was liquidity.
Rather, onemerlin stated that Dodd Frank required all assets to be valued, based on mark to market: factually, that is not correct.
Yes sorry did not mean to imply disagreement at all.
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Accordingly to a friend/former classmate who makes his living as a bank analyst: "Its not clear that being a systemically important bank, would have stopped SVB's failure. The regulation would have required SVB to have a more robust plan around failure. The so called, will."
It is my understanding that the Bank went for the past 10 months without a Risk Management Officer....had this position been filed as seeming is required...it is possible that the bank would have had a better understanding of their Risk with seemingly safe government bonds and would have hedged this position...everyone in the Universe knew the Fed's interest rate policy....carried risks.
Even I have tried to minimize this destruction to my portfolio...and not been entirely successful either....but I certainly knew it was there and I tried.
Going forward...I haven't a clue what this all might mean.
Without a Chief Risk Officer, from April 2022 to January 2023. Which is somewhat odd in the face of an escalating risk profile.
The risk they had is not "seemingly safe government bonds" but rather a huge pile of that in long-dated bought as placement as they experienced a massive influx of liquidity in 2020-2021 that they did not lend out, bought before the acceleration of rates by all large central banks - and so long-dated bonds against sight deposits that also were massively jumbo corporate, notoriously the most volatile and footloose kind of deposits, with barely any small retail deposits.
Really by mid 2022 this should have been obviously something to unwind.
It would appear they would have been required to do more extensive liquidity stress testing (for capital regs profile see: https://www.sifma.org/resources/news/understanding-the-current-regulatory-capital-requirements-applicable-to-us-banks/) under Category III so as the other comment noted, forced in some fashion to address the clear escalating liquidity risk rather earlier, depending on the exact approach of the regulators (perhaps forced to progressively reprofile their long-dated securities into short-maturities taking smaller near-term hits but not blowing up or having to deal with in full out house-on-fire crisis). Marking the securities hold-to-maturity is not per se a sin, but in the context of clear evident escalating liquidity risk given in essence they had made a bizarre doubled down one-way bet on rates.
Also see Forbes commentator, https://www.forbes.com/sites/mayrarodriguezvalladares/2023/03/11/warning-signals-about-silicon-valley-bank-were-all-around-us/?sh=130842591e10
My question is, these rate hikes weren't a surprise, so how were they not looking out for this? Everyone has known rates have been going up for a year. They didn't know for sure how much they would go up or when they would stop going up, but if you're particularly sensitive to rate hikes, you should have been looking at this. Did they not realize the potential impact? Was it such a fluke run that they couldn't have predicted?
I've also read that the overwhelming majority of their accounts had more than 250K in them. Is that normal for big banks? It seems rather risky to me. FDIC insurance helps reduce the panic that causes bank runs, but that won't help much if most of your depositors are largely uninsured.
No, it is not normal for any Commercial Bank (deposit taking bank) - SVB had a very peculiar funding profile. And a very peculiar effectively single sector focus in both their lending AND their corporate deposit base.
Most Commercial Banks seek to have diversification, not to be so heavily depending on jumbo corporate deposits which everyone in banking knows are flighty and footloose....
The fact they went almost a year (April 22-Jan23) without a Chief Risk Officer is strange and something of a red flag.
From 2019 to 2021, deposit totals at SVB jumped dramatically, going from $40B to $180B. The bank had to figure out how to invest that $140B.
The bank quickly shifted from investing in mostly low-yield, govt backed, short term bonds/securities to mostly slightly higher-yield, govt backed, long term bonds.
Remember that yields were really, really low at the time and getting a slightly higher rate on $90B of investments is a lot of money.
While it all looks obvious now, it certainly wasnt obvious in 2020 and 2021 that the Fed would undertake the most dramatic increase in rates that the US has ever seen.
When rates began to jump in 2022, the market value of the banks investments in long-term, low-yield bonds began to fall. But the bank doesnt have to recognize these losses until they sell and they probably dont need to sell unless there is a major run on withdrawals. Because of who their investors were, there was a legitimate risk of a surge in withdrawals.....but the option of selling bonds prior to a run on withdrawals would still require massive losses to be realized once the sales occurred. These preemptive sales to get rid of low yield bonds and acquire newly issued higher yield bonds might have triggered a run or pushed the bank into insolvency many months ago.
Buying long term bonds just before the Fed started raising rates sure looks dumb now. But in mid-2021 the Fed was projecting that the 2023 Fed funds rate would be 0.6%. By fall-2021 the Fed was still projecting a 1% Fed funds rate in 2023. Even as late as March '22 the Fed was projecting a 2023 rate around 2.8% That the Fed rate would top 4% in early 2023 was certainly not obvious.
I dont know how SVB would have fared in an alternate reality 2023 where rates were under 2 or 3%. We can say with certainty that buying a lot of long term bonds is a risky thing for a bank to do.
Its probably not a coincidence that SVB grew rapidly but stopped their growth just short of where additional reporting requirements would have kicked in.
For precision, their business was lending to Venture backed start-ups (or VC backed companies if not strictly speaking start-ups).
That massive deposit inflow was beyond what they could find a way to lend out in their focus business.
The fact they did not have a Chief Risk Officer from April 2022 to Jan 2023 is frankly baffling and clearly was A Bad Thing.
I entirely agree with 2020 eyes or 2021 eyes the steps taken in 2020 and 2021 were not irrational nor utterly stupid, even if blind or perhaps underestimating rate risk.
But in 2022 the alarm bells should have started and some kind of unwinding effort (of course one does have to admit as you note that any effort could bear a panic risk given their depositors profile of uninsured Jumbo corporate deposits which anyone in banking knows are footloose and prone to bolt...)
I find these explanations by Lounsbury, as well as his extensive comments in Kevin's previous post on this subject, to be (a) thorough, and (b) thoroughly convincing. The main thrust of the Dodd-Frank legislation was to manage risk better. To a great extent, the seemingly innocuous action of the Congress to relax the risk management requirements of banks below the level of "the biggest" has let players as big as SVB to laughingly ignore the risks of their policies and their decisions.
And reportedly the guy who ran SVB lobbied very hard for that regional-bank exemption from Dodd-Frank provisions. Whether he did that on general (libertarian-ish) Val-culture principles or for more institution-specific reasons would be worth knowing.
There are in my opiinion (from someone working in emerging markets, and as my regulatory background is there too) legitimate trade-off issues raised by smaller banks on the burden and cost of the Basel III and other full-kit bank regulation.
Easy to opine on should do X, or Y or Z abstractly but there are costs to that, and costs get passed through ... so it is not I think entirely wrong-headed for Regional banks to argue for tailoring to their size...
But where to draw the thresholds, probably there is never going to be a perfect answer and even a good enough answer in 2010 may not be permanently the right answer.
Smaller community banks and mid-sized institutions had been clamoring for a long time to have some of the Dodd-Frank requirements eased for them, claiming that they did not pose systemic risks and that compliance costs were too high. I believe the deregulation Trump signed off on was intended to address this issue. The bill, as I understand it, raised the size of a bank's asset limit before it became subject to D-F's more stringent liquidity and capitalization requirements. SVB appears to have come in just under the cutoff.
It appears that SVB had a major mismatch on duration. Demand deposits are the ultimate in short-term liabilities; as the run on SVB shows, you can't count on them from day to day. Against that, a sensible financial institution puts the bulk of its assets in short term, extremely liquid assets. Long bonds were a bad idea; SVB should have been holding a portfolio of securities with maturity dates not more than six months out, and a portion of them maturing at least every week, if not every day.
Agreed particularly given the Hot Money nature of the inflows. The mismatch issue is really about the liquidity profile need not only as their demand deposits were uninsured but they were (1) of corporate profile known to be quite footlose, (2) exteme market-and-geography concentration, so if there was a deposit flight say for cash needs on declining revenue for example, correlation risk was super high, (3) deeply socially interconnected client base (Bonjour Contagion...)
What does the small local bank do with its money? Puts a lot of it into long-term mortgages. Of course the average actual duration of mortgages is a lot less than 30 years. That duration will be longer than average in the future as there is no incentive for those who got mortgages at the historically low rates that have prevailed for 10 years to refinance. How much of the average (non-Silicon Valley) bank is in long-term loans?
The Fed directors seem to think that they are putting down the wage demands of uppity workers when they raise rates, but it makes it difficult for banking in general.
Fed Directors are not your bizarre Left Populist strawman so you will never really understand ....
However rate rises in fact generally if not too fast for adjustment are positive for most Commercial Banks as in fact business lines are aiming at a mix of short, medium and long-term lending, and mix of fixed and variable rate. It is in fact generally better for profit in a predictably rising rate environmet getting away from the extreme rate compression.
"In practical terms, the banks deregulated by the section would:
(i) no longer have to file living wills with regulators to plan for their orderly failure;
(ii) no longer be subjected to new post-crisis liquidity requirements that ensure banks are able to meet their obligations during a period of stress;
(iii) no longer perform company-run stress testing that enhances the risk management capacity of banks; and
(iv) will not be constrained by proposed single counterparty credit limits that aim to limit risks that distress at one bank but will tear down another."
https://morningconsult.com/opinions/senates-bipartisan-dodd-frank-rollback-proposal-is-a-raw-deal/
Pay attention to (ii)
Et voila yes
(ii) no longer be subjected to new post-crisis liquidity requirements that ensure banks are able to meet their obligations during a period of stress;
from this AM guess, the liquidity testing should have triggered at some point perhaps in early 22 regulators obliging SVB to begin to address that long-dated bond portfolio in bringing it down one presumes progressively reprofiling - the practical probable action (to respond to the Drum Q.
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It would appear they would have been required to do more extensive liquidity stress testing (for capital regs profile see: https://www.sifma.org/resources/news/understanding-the-current-regulatory-capital-requirements-applicable-to-us-banks/) under Category III so as the other comment noted, forced in some fashion to address the clear escalating liquidity risk rather earlier, depending on the exact approach of the regulators (perhaps forced to progressively reprofile their long-dated securities into short-maturities taking smaller near-term hits but not blowing up or having to deal with in full out house-on-fire crisis). Marking the securities hold-to-maturity is not per se a sin, but in the context of clear evident escalating liquidity risk given in essence they had made a bizarre doubled down one-way bet on rates.
Nothing would have been different under the old rules. The overarching rule is the right sorts of people with the right connections get bailed out no matter the cost or consequences, and poste haste too. Banks know this. You don't go without a risk officer for most of a year if you think there is any real risk. All this hooey about the shareholders and executives getting wiped out should be revisited in a year to see what really happens.
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Out of my depth in all intricacies above this comment, but from what I can gather everything a bank does is to acquire profit. Lobbying for easing of regulations aims to improve profit. Plans for investment and loaning money are for profit. Risk assessment aims to make profit. The entire system of banking itself aims to make profit. If an implosion such as this odious episode can cause so much damage (and so far the center holds), the system is suicidal. If the center does not hold, the system is homicidal. Act accordingly.
This has all happened before and so shall again.