The sudden collapse of two U.S. banks recently left many people wondering about the safety of their own deposits, the health of the banking system and consequences down the road.
Mary Ann Scully, the former CEO of a Baltimore-based bank, has been hearing a lot of such concerns since a bank run hit Silicon Valley Bank and it was taken over by federal regulators, a chain of events that triggered a similar run at New York-based Signature Bank. Bankrate lists those failures as two of the three biggest in U.S. banking history.
“The big fear now is, of course, is this some indication of systemic risk, and does this mean there’s more dominoes to fall?” said Scully, dean of the Rev. Joseph A. Sellinger, S.J., School of Business and Management at Loyola University Maryland and co-founder of Howard Bank, which was sold last year. “I would say I don’t think that is the case — which is not to say that no one else will get into trouble.”
Scully and other experts said they believe Silicon Valley and Signature faced a unique set of circumstances among banks that led to their failures and that are unlikely to be replicated in the same way at other institutions.
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“We’ve heard a lot of rumblings, but as you can see, there’s not a lot of banks falling apart all over the place as some might have thought would be the case,” said Marbue Brown, a former JPMorgan Chase “customer experience” executive and head of New York-based consulting firm The Customer Obsession Advantage.
Some say government intervention has stabilized the system and stemmed the panic while others view those steps as merely delaying, not solving, problems.
Federal regulators stepped in last weekend to guarantee all the deposits of both banks, beyond the $250,000 insured by the Federal Deposit Insurance Corp. That calmed worried depositors and investors briefly, but fresh fears emerged again Wednesday as Credit Suisse, a big European bank, appeared vulnerable.
On Friday, President Joe Biden called on Congress to enact laws giving regulators more power to hold bank executives responsible. Specifically, the Democratic president wants regulators to be able to claw back pay, impose fines and limit employment in the industry for executives accused of mismanagement.
Michael Faulkender, dean’s professor of finance at the University of Maryland’s Robert H. Smith School of Business, blames Silicon Valley Bank’s failure on bad timing, bank mismanagement and insufficient Fed oversight.
A commercial bank that specialized in lending and deposits for tech and health care startups, Silicon Valley Bank had invested heavily in long-term Treasury bonds. Such investments typically would have been considered safe, Brown said. But bonds lost value as the Federal Reserve hiked interest rates 4.5 percentage points in the past year to control inflation. The bank realized losses when it found itself needing to liquidate bonds before they matured.
Silicon Valley Bank “had this massive deposit influx,” said Faulkender, who served as assistant secretary for economic policy in the Treasury Department from 2019 to 2021.
“From a risk-management perspective, they incorrectly bought long-term bonds,” he said. “The massive increase in interest rates devalues the bond. They have to then sell the bonds to meet the needs of the depositors, and they took losses.”
He added that “any bank that’s sitting on that combination is potentially also in trouble,” questioning why regulators weren’t more closely monitoring interest-rate risk at Silicon Valley Bank after raising rates.
Kathleen Day, a lecturer at the Johns Hopkins Carey Business School who specializes in financial crises, also questioned the involvement of regulators and said oversight of investment risk has been too lax under recent exemptions for certain-sized banks.
“Someone should have been going in there and doing a stress test, and they weren’t because [the bank] was exempted,” Day said. “It turns out that by exempting this bank from some common-sense rules, when the unexpected happens they got hit.”
Brown said another unique circumstance came into play with Silicon Valley. The bank tended to serve startup founders and CEOs, a savvy clientele that paid more attention to their bank’s investments — and communicated with one another about them — than the average depositor. Ultimately, venture capital firms, some of which were customers, warned their own portfolio companies, which led to many rushing to withdraw money.
“Your average customer out there is not looking at financial statements of their banks, and they’re not looking at things like liquidity and audit statements ... and then they’re not going out there and talking to each other and saying, ‘Hey, I’m taking my money out of the bank,” Brown said.
But even if other institutions become distressed, customers should feel reassured by steps taken March 12 by the Federal Reserve, the FDIC and the Treasury Department to mitigate the impact on depositors, said Scully, noting the move to protect depositors.
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Meanwhile, the Federal Reserve’s Bank Term Funding Program will allow banks to borrow funds for up to a year, using their securities portfolios as collateral at face value.
“Both are things that should go a long way toward assuring people that if there are others in a slightly similar situation,” their depositors would get the same protections, Scully said. “And it should provide assurance to banks that they have time to work their way through some of these underwater investment securities and some of the drawdown in deposits occurring because of economic forces.”
Allowing banks to use devalued bonds as full collateral could just “kick losses down the road,” Faulkender said. But, on the other hand, it also “will stem any panic.”
Silicon Valley Bank found itself in a unique situation, experts said. While all banks look for ways to increase their profitability and also may have invested in securities, the size of Silicon Valley’s “underwater” securities portfolio was much larger as a percentage of assets and capital base than at most banks, Scully said.
That was partly because of the bank’s unique business model. It took deposits from young tech companies that had received venture funding and held them while they burned down capital until the next equity raise, placing the money in securities rather than lending it out.
While Silicon Valley Bank, in hindsight, was taking more interest rate risk, it also was seeing its deposit base grow quickly, as were other banks during the coronavirus pandemic, because of government funding programs.
Silicon Valley’s balance sheet more than doubled in a hot technology market as more people took up activities such as streaming and teleworking during the health crisis. That rapid growth left the bank with a big chunk of newer and more volatile deposits.
“It’s a multiplication of risks,” Scully said. “The level of interest rate risk. The level of deposit growth. The concentration of deposit growth in companies that now are drawing down their capital ... because they’re not doing the same level of equity raises. The exposure to a subsector of the economy,” and a higher-than-normal exposure to uninsured deposits.
In the end, customers lost confidence in Silicon Valley and the bank ran out of time.
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“All banks are dependent on confidence,” Scully said. “Nobody has the deposits of all of their customers sitting in a checking account someplace.”
Experts are divided on whether insurance should continue to be extended to depositors’ uninsured funds.
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Scully noted that a precedent exists. In 2010, under the Dodd-Frank Act, checking accounts were receiving unlimited FDIC insurance for a couple of years.
Faulkender said he believes it’s a mistake to guarantee uninsured deposits and that all depositors will bear the burden of increased deposit insurance fees.
“If a CFO of a tech company can’t be held responsible for understanding that their deposits are uninsured, who can we hold responsible for it?” he said. “They put their money above the insurance limit because [Silicon Valley] was offering higher interest rates than other banks. ... They took a risk.”
He said he believes any panic will subside and things will settle down.
“But you just set the groundwork for problems in the future,” he said. “Did we just reward bad behavior? Are there going to be consequences for that in the future?”