Experts React: The Collapse of Silicon Valley Bank in National and International Contexts
A deposit run at California-based Silicon Valley Bank (SVB) led state regulators to place the bank in receivership on Friday, March 10. Other regional banks also came under pressure, and regulators moved to stem further contagion of the U.S. financial system. On Sunday, March 12, the U.S. Department of the Treasury, Board of Governors of the Federal Reserve System, and Federal Deposit Insurance Corporation (FDIC) issued a joint statement announcing “decisive actions to protect the U.S. economy by strengthening public confidence in our banking system.” These actions include invoking the “systemic risk exception,” to guarantee 100 percent of demand deposits—even those above the $250,000 statutory cap—at SVB as well as New York-based Signature Bank. In addition, the Federal Reserve announced it would make available additional funding to eligible depository institutions through the creation of a new Bank Term Funding Program (BTFP). On Monday, President Biden reassured the public that the U.S. financial system was safe; as of Tuesday morning, midsize lenders’ stocks had partially recovered from precipitous losses the previous day, and the situation remains fluid.
Quick Action to Stem Contagion
Senior Fellow, Economics Program
Most Americans probably had not heard of SVB a week ago, but the failure of the sixteenth-largest U.S. bank last week continues to reverberate across the country and beyond. U.S. regulators have moved quickly to stem the contagion, and the jury is still out as to what, if any, additional measures might be required to calm financial markets.
Some analysts had been warning that the Federal Reserve’s interest rate hikes posed risks to the broader economy, but few understood the perfect storm that was brewing at SVB. More will become clear in the weeks ahead, but it appears SVB fell victim to a concentrated customer base—many of whom were drawing down deposits as financing became tougher to raise in a higher rate environment—and unhedged holdings in longer-dated bonds. This resulted in a maturity mismatch, with SVB’s assets (including U.S. Treasury bonds and mortgage-backed securities) unable to fund deposit outflows without incurring a loss on the sale of those assets. (As interest rates increase, the price of the underlying asset falls. If the bond is held-to-maturity, there is no loss, but when sold at the prevailing market price, losses are realized.)
The Federal Reserve’s creation of the BTFP will help eligible institutions facing a similar situation as SVB. With the new facility, an eligible institution can pledge its holdings of U.S. Treasury bonds, agency debt, and mortgage-backed securities as collateral, rather than sell the securities at a loss. In this respect, the facility builds on innovations from the early days of Covid-19, when the Federal Reserve established a facility to provide foreign central banks with access to dollars in exchange (temporarily) for their holdings of U.S. Treasuries. As with the Foreign and International Monetary Authorities Repo Facility, access to the BTFP for the most part does not entail credit risk to the Federal Reserve, given up to $25 billion from the Exchange Stabilization Fund as a backstop for the BTFP, plus full collateralization by U.S. Treasuries, agency debt, mortgage-backed securities, and other qualifying assets in exchange for funding. (This assumes the United States will not default on its obligations, historically a safe bet.)
With the facility, the Federal Reserve is helping where it can: on the asset side of banks’ balance sheets. On the liability side—specifically depositors in the case of SVB—the regulator’s job is to give confidence to depositors that their deposits are safe. It will start to become clear how well regulators did their job in the days ahead. But in a world where a single tweet or email to a small number of large depositors can spark a bank run, it might be asking too much of regulators to guard against that type of risk.
Decisive Action, But at What Cost? The Policymaker’s Burden
Senior Fellow, Economics Program
Washington’s interventions to guarantee SVB’s deposits were justified based on fears of wider contagion. This could affect U.S. regional banks with a large share of deposits above the FDIC’s $250,000 insurance limit. Whether Washington’s actions will be sufficient to prevent further bank runs is not yet clear.
U.S. policymakers faced a major trade-off: (1) limit the scope of deposit guarantees, at the risk of triggering flight among large depositors to only the largest, systemically important banks, or, as they chose, (2) expand deposit guarantees to stabilize the system, at the risk of needing to expand guarantees even further, with uncertain consequences for U.S. taxpayers. One can debate what the optimal policy response should have been, but one should at least concede that U.S. financial officials have once again demonstrated they can act quickly and decisively if needed.
Global markets’ fixation on this event reaffirms the centrality of the U.S. financial system and the importance of sound regulatory and central bank oversight. Global investors rely on U.S. dollar assets for their international portfolios or reserves in part because they trust the United States to manage its financial markets responsibly.
International risks from SVB’s failure are likely minimal absent a much wider crisis with macro implications. This might have been different if Washington had not guaranteed all deposits because of the damage it would have done to many tech firms, which themselves often have foreign investors, at least as limited partners in venture capital funds. Regional U.S. banks currently in the market’s crosshairs are domestically focused.
Stepping back, the U.S. and global financial systems have not yet fully manifested the costs of quickly ending more than a decade of record-low U.S. interest rates. Yes, real borrowing costs—when adjusted for inflation—are not particularly high, but balance sheets are nominal. As the Federal Reserve and other central banks continue their efforts to stem inflation, more financial flashpoints will emerge. This increases the importance of international coordination and raises questions about the costs of relying solely on monetary policy to manage macro-level demand.
SVB Opens Up a Big Can of Worms for Rumination
Senior Adviser (Non-resident), Economics Program
The anti-bailout and moral hazard crowd’s screaming will become feverish. The Federal Reserve and Department of the Treasury were justified in insuring depositors via the systemic exception. Today’s challenge is managing the crisis, limiting the damage from extreme market turmoil and contagion. Corrective actions are for tomorrow.
Expectations about monetary policy tightening are being scaled back, yet inflation remains problematic. Many Federal Reserve officials have long argued that good micro- and macro-prudential oversight means that financial stability concerns can be cordoned off from monetary policy.
SVB was the United States’ sixteenth-largest bank and not seen as systemic. Yet, its contagion and interconnectedness show otherwise. Enhanced prudential standards had been relaxed for the United States’ huge “medium-sized” and regional banks. The United States needs to significantly lengthen the list of banks considered “systemic” and submit them to far more rigorous supervision.
Many will blame the Federal Reserve’s rate-hiking cycle for SVB’s collapse. That would be facile. Other firms are coping with those hikes and not collapsing. SVB’s concentrated portfolio, disproportionately large uninsured deposits, strong deposit growth, and large—and reportedly unhedged—bond portfolio should have thrown up red flags to regulators. An investigation of whether and why the regulators failed to do their jobs is in order.
Stephanie Segal is a senior fellow with the Economics Program at the Center for Strategic and International Studies (CSIS) in Washington, D.C. Gerard DiPippo is a senior fellow with the CSIS Economics Program. Mark Sobel is a senior adviser (non-resident) with the CSIS Economics Program.