What went wrong with the U.S.’s 16th largest bank and how has it affected the rest of the sector? Andrew Pimlott explains:
Silicon Valley Bank’s (SVB) failure on Friday, March 10th was the biggest since the 2008 financial crisis. Then, two days later on Sunday, came the fall of Signature Bank. The U.S. government and regulators were quick to rescue both banks to protect the financial system, but it was not enough to prevent the contagion spreading across the country’s banking sector and to the other side of the Atlantic.
Confidence in Silicon Valley Bank’s UK subsidiary evaporated and it had to be saved by HSBC, who bought it for £1 on the Monday after a weekend of frantic discussions involving the Bank of England, HM Treasury, and the financial regulators. Yet, the panic could not be contained. The next high-profile victim was Swiss banking giant Credit Suisse which saw its shares fall 30% on Wednesday, March 15th. It had to borrow SFr50bn ($54bn) from the Swiss central bank and buy back around SFr3bn ($3.24bn) of its debt to improve liquidity and reassure investors, but at the time of writing, its share price had not fully recovered. Another institution badly affected was First Republic Bank, the U.S.’s 14th biggest. Its shares fell 70% in a week, the largest U.S. banks have deposited a joint total of $30bn to bolster its finances and there are rumors it is exploring a sale.
So, how did Silicon Valley Bank’s woes begin, and how did its fate impact the rest of the banking system? The bank was set up in Santa Clara, California, in 1983, with a business model designed to provide financial services to early-stage and growth-stage companies and their investors in the technology, life sciences, healthcare, and energy sectors.
Between 2020 and 2022 its deposits tripled in size during the technology boom of the pandemic and it became the country’s 16th biggest bank. Some deposits were re-invested in other technology start-ups and in VC (Venture Capital) firms, but much was invested in long-term U.S. Treasury and mortgage bonds which delivered reliable but small returns in a low-interest rate environment.
Then, early this March things started to unravel. Here is a day-by-day account of what happened.
Wednesday, March 8th
Silicon Valley Bank announces it has sold $21bn of securities, including Treasury and mortgage bonds. However, the sale generates a loss of $1.8bn because the securities have fallen in value in the past 12 months. The bank announces plans to raise $2bn extra capital through a share sale to shore up its balance sheet.
Thursday, March 9th
The bank’s shares fall 60% because investors are concerned about its dire financial position. It becomes clear the share sale will not work. Its depositors, mainly technology start-ups and VC firms, began withdrawing their money over fears it will fail. Reports surface of customers being unable to use the bank’s website to access their funds to pay staff and other expenses.
Friday, March 10th
More customers withdraw their money, creating a run on the bank and bringing it to the verge of collapse because it cannot find enough cash to pay depositors. The California Department of Financial Protection and Innovation closes the bank and appoints the Federal Deposit Insurance Corporation (FDIC) as receiver.
To protect insured depositors, the FDIC creates the Deposit Insurance National Bank of Santa Clara (DINB) and immediately transfers to the DINB all insured deposits of Silicon Valley Bank. However, the FDIC only insures deposits up to $250,000, so, depositors with greater funds still risk losing some or all of their money above the threshold. It is the largest bank crash since the 2008 financial crisis. Bank shares fall and some suffer large withdrawals.
Meanwhile in London, the Bank of England says it intends to place Silicon Valley Bank UK into a bank insolvency procedure. This means the bank must stop making payments and taking deposits. Eligible depositors will be paid out by the Financial Services Compensation Scheme (FSCS) up to the protected limit of £85,000 or £170,000 for joint accounts. Deposits above that amount, along with SVB UK’s other liabilities and assets, would be managed by the bank liquidators and “recoveries distributed to its creditors.” The Bank of England adds that “SVB UK has a limited presence in the UK and no critical functions supporting the financial system,” indicating it believes no further action is required.
Saturday, March 11th
In the U.S., high-profile investors and technology company executives criticize the lack of government action to guarantee Silicon Valley Bank depositors’ funds above the $250,000 threshold.
Sunday, March 12th
Signature Bank, based in New York and the country’s 29th biggest bank, suffers a bank run and is closed by the New York State Department of Financial Services, which appoints the FDIC as receiver.
Fearing the crisis will spread, the FDIC, Treasury Department, and the Federal Reserve Board inform depositors in SVB and Signature that they will, after all, guarantee all deposits including those above $250,000. Signature’s assets and deposits are transferred to a new “bridge bank” called Signature Bridge Bank operated by the FDIC, with full banking activities to resume on Monday, March 13th. The Federal Reserve announces a program to lend to distressed banks to help them return money to depositors and restore confidence in the financial system.
Monday, March 13th
Just before London’s markets open, HSBC announces it will buy Silicon Valley Bank UK for £1. The decision followed an intense weekend of crisis negotiations involving the Bank of England, Prudential Regulation Authority, HM Treasury, and the Financial Conduct Authority. Although the central bank had said on Friday, March 10th, that SVB UK had “no critical functions supporting the financial system,” that it would be put into insolvency, and that deposits above the FSCS limit would not be protected, it changed its mind on Monday, March 13th. It says that in the interests of “ensuring the continuity of banking services, minimizing disruption to the UK technology sector, and supporting confidence in the financial system,” Silicon Valley Bank UK has been sold to HSBC. Contrary to its statement Friday, March 10th, it says SVB UK will not be put into insolvency, all depositors' money above the FSCS threshold will be safe and the bank “will continue to operate as normal.”
In the U.S., the FDIC transfers all deposits – insured and uninsured – and most assets of Silicon Valley Bank to a new bridge bank called Silicon Valley Bridge Bank. The bank is operated by the FIDC and banking services start the same morning.
President Biden addresses the nation to say the banking system and people’s deposits are safe. Even so, the share price of many banks drop dramatically. The Federal Reserve Board announces that in light of Silicon Valley Bank’s failure, it will set up a review into how it was supervised and regulated.
Tuesday, March 14th
Bank share prices remain depressed in the U.S. and Europe. The Wall Street Journal reports that the Justice Department and the Securities and Exchange Commission are investigating the Silicon Valley Bank collapse.
Wednesday, March 15th
Thursday, March 16th
Credit Suisse and First Republic announce measures to strengthen liquidity and reassure customers. Treasury Secretary Janet Yellen, in a prepared testimony ahead of a Senate Finance Committee hearing, attempts to calm fears: “I can reassure the members of the Committee that our banking system remains sound and that Americans can feel confident that their deposits will be there when they need them.”
What does Silicon Valley Bank have to say?
Amidst all the turmoil, the bank has kept its communications to a minimum. It has left the regulators to do most of the talking. A prominent message on its website now declares: “Silicon Valley Bridge Bank NA is a newly created, full-service FDIC-operated ‘bridge bank’. The bank is open for business and new and existing depositors have full access to their money and protection for their deposits.” Links are given to legal information and the FDIC website.
New Chief Executive Officer Tim Mayopoulos issued a statement on March 13th, the day he took office, saying Silicon Valley Bridge Bank is open and conducting business as usual. “I recognize the past few days have been an extremely challenging time for our clients and our employees, and we are grateful for the support of the amazing community we serve,” wrote Mayopoulos, who was CEO of Fannie Mae from 2012 to 2018.
As for the UK subsidiary, its website carries a brief statement that explains that “following events impacting our former parent company in the US, the UK Government worked to find us a financially strong and stable partner.” It provides a link to HSBC which gives more information.
Did the Basel III and U.S. liquidity regulations apply?
The short answer is no. The Basel III accord – created by the Basel Committee on Banking Supervision after the 2008 global financial crisis and which has been adopted by the U.S. and many other countries around the world – sets minimum ratios for capital adequacy, leverage, and liquidity. The relevant rules in the case of the Silicon Valley Bank debacle are the ones on liquidity. Daniel Davies, Managing Director of Frontline Analysts, a London banking consultancy, says the rules work, but U.S. regulators have only applied them to a few of the largest international banks, not to Silicon Valley Bank and the rest.
Basel III created two new ratios designed to reduce the risk of banks running short of funds. “First is the ‘Liquidity Coverage Ratio’ (LCR), which is meant to measure emergency funding capacity,” he writes in the Financial Times. “In simple terms, it’s the ratio of the amount of ‘High Quality Liquid Assets’ (HQLA) you have available, compared to a rough-and-ready estimate of the cash outflows you might experience over 30 days if your wholesale funding dried up and some (but not all) of your retail and corporate deposits ran. The ratio is meant to be above 100 percent; it corresponds broadly to a 30-day ‘survival horizon’.”
The second is the “Net Stable Funding Ratio”(NSFR) — also meant to be above 100 percent in a good bank — which measures structural funding liquidity. Assets are assigned weightings according to how easy they are to turn into cash. Liabilities get weightings according to the likelihood that someone will want cash back immediately.
So, why did these regulations not prevent Silicon Valley Bank from going under? The answer, explains Daniel Davies, can be found in the bank’s most recent 10-K financial report filed to regulators which states that because of its relatively small size “we currently are not subject to the Federal Reserve’s LCR or NSFR requirements, either on a full or reduced basis.” Although most countries apply the Basel rules to all banks, this is not the case in the U.S. where they are only applied to the largest international banks.
“The European and UK banks basically managed to become compliant with the funding rules, which in many ways just codify sensible treasury management practices,” concludes Daniel Davies. “The fact that large domestic banks in the US are apparently allowed to run such sizable funding mismatches is likely to be a source of embarrassment to the US authorities.”
If the Basel III and U.S. liquidity regulations had been applied, would they have saved the bank?
The answer is probably no, according to Bill Nelson, Chief Economist at the Bank Policy Institute (BPI) in Washington DC. “In the wake of the failure of Silicon Valley Bank, some bank critics have alleged that this relief [from the LCR regulation] was a proximate cause of that failure,” he writes in an analysis for the BPI. “Of course, that raises a factual question that they have not addressed: Would SVB’s problems have been caught by the LCR, and would it have had to fund itself in a more sound way? The answer appears to be no. SVB probably would have received a passing score on the LCR.”
He goes on to explain, supported with detailed calculations and tables, why Silicon Valley Bank would have met the LCR if it had been required to comply with it but would have still failed.
The LCR is based on two key components – high quality liquid assets (HCLA) and net cash outflows – and the former must be the same as, or higher than, the latter in stressed conditions. He estimates that the bank had HQLA worth $52.8bn and net cash inflows (after adjustments) of $35.2bn, meaning its LCR would have been 150% ($52.8bn divided by $35.2bn x 100), well above the requirement for the "LCR to be equal to or above 100%.”
So, even if SVB had been subject to the LCR rules, it would have met them – and still crashed. Why? Because the underlying cause of the bank’s failure was interest risk, avers Bill Nelson. “Its problem was not that it did not hold liquid securities like Treasuries and agency-guaranteed mortgage-backed securities. Its problem was that those securities were long-term and paid low-interest rates and thus suffered extraordinary losses when rates rose. That’s not a problem that the LCR is designed to catch.”
He says the failure of SVB appears to reflect primarily a failure of management and supervision rather than regulation. “In particular, SVB took on extensive interest rate risk that resulted in large losses that undermined confidence in the bank and triggered a run. Such fundamental risk management is first and foremost the responsibility of bank management and then the province of supervision.”
It's complicated. It just goes to show that no matter how frequently regulations are updated – the first version of the Basel accord dates back to 1988 – and how many procedures and quantitative models banks create to manage the risks they face, it can all fall apart if people make the wrong decisions.
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