Where Were the Regulators as SVB Crashed?
Silicon Valley Bank grew too fast using borrowed money—and the risks were lurking in plain sight
Silicon Valley Bank’s failure boils down to a simple misstep: It grew too fast using borrowed short-term money from depositors who could ask to be repaid at any time, and invested it in long-term assets that it was unable, or unwilling, to sell.
When interest rates rose quickly, it was saddled with losses that ultimately forced it to try to raise fresh capital, spooking depositors who yanked their funds in two days. The question following the bank’s takeover Friday: How could regulators have allowed it to grow so quickly and take on so much interest-rate risk?
And it wasn’t the only problem bank last week. Just days before SVB SIVB -60.41% collapsed, Silvergate Capital Corp. SI -11.27% , one of the crypto industry’s biggest banks, said it would shut down.
“The aftermath of these two cases is evidence of a significant supervisory problem,” said Karen Petrou, managing partner of Federal Financial Analytics, a regulatory advisory firm for the banking industry. “That’s why we have fleets of bank examiners, and that’s what they’re supposed to be doing.”
The Federal Reserve was the primary federal regulator for both banks.
Notably, the risks at the two firms were lurking in plain sight. A rapid rise in assets and deposits was recorded on their balance sheets, and mounting losses on bond holdings were evident in notes to their financial statements.
SVB grew at a breakneck pace, nearly doubling deposits in just a year. Total assets at its parent, SVB Financial Group, grew to $211 billion at the end of 2021, versus $116 billion a year earlier. By the end of 2022, SVB was the 16th largest lender in the U.S. Its implosion was the second-biggest bank failure in American history and marks the biggest test to date of the post-financial crisis regulatory architecture designed to force banks to curtail risk and monitor it more closely.
“Rapid growth should always be at least a yellow flag for supervisors,” said Daniel Tarullo, a former Federal Reserve governor who was the central bank’s point person on regulation following the financial crisis. That’s because risk controls and buffers against potential losses often don’t grow in line with new risks being taken by fast-growing banks.
In addition, nearly 90% of SVB’s deposits were uninsured, making them more prone to flight in times of trouble since the Federal Deposit Insurance Corp. doesn’t stand behind them.
“A $200 billion bank should not fail because of liquidity,” said Eric Rosengren, who served as president of the Federal Reserve Bank of Boston from 2007 to 2021 and was its top bank regulator before that. “They should have known their portfolio was heavily weighted toward venture capital, and venture-capital firms don’t want to be taking risk with their deposits. So there was a good chance if venture-capital portfolio companies started pulling out funds, they’d do it en masse.”
SVB and Silvergate both had less onerous liquidity rules than the biggest banks. In the wake of the failures, regulators may take a fresh look at liquidity rules, with an eye toward adjusting the requirements for holding high-quality liquid assets for banks whose funding sources go far beyond retail deposits, said Jaret Seiberg, an analyst at TD Cowen Washington Research Group, in a note.
To be sure, banks regularly borrow short-term to lend for longer periods of time. But SVB concentrated its balance sheet in long-dated assets, essentially reaching for yield to bolster results, at the worst possible time, just ahead of the Federal Reserve’s rate-hiking campaign. That left it sitting on big unrealized losses, making it more susceptible to customers pulling funds.
Timothy Coffey, associate director of depository research at Janney Montgomery Scott LLC, said regulators were aware that unrealized losses in banks’ securities portfolios could lead to trouble, but didn’t take specific steps to address the issue.
“This is something that’s been rolling through the industry for several months,” he said. “They did nothing to help this bank,” he added, referring to SVB.
Indeed, the two firms aren’t the only ones facing the risk posed by unrealized losses. The banking industry as a whole had some $620 billion in unrealized losses on securities at the end of last year, according to the Federal Deposit Insurance Corp., which began highlighting those late last year.
Another regulatory issue: accounting and capital rules that allow banks to ignore mark-to-market losses on some securities if they intend to hold them to maturity. At SVB, the bucket holding these securities—consisting largely of mortgage bonds issued by government-sponsored entities—is where the biggest capital hole is.
The idea behind such a bucket is that it insulates an institution from short-term price volatility. The problem this poses is two-fold.
First, a bank may not be able to hold such securities to maturity if it faces a cash crunch, as happened at SVB. Yet selling the securities would force the bank to recognize potentially massive losses.
Second, the treatment of the securities means banks like SVB are discouraged from selling when losses emerge, potentially causing problems to fester and grow. That appears to have been the case at SVB and many other banks as rising interest rates in 2022 caused large losses in bond markets.
Banks have an additional incentive to pile into Treasurys. They have to hold less capital against such holdings, supposedly because they are risk-free. However, this means banks are holding less capital to absorb losses, and Treasurys can lose value due to changes in interest rates.
Others said monetary policy over the past decade played a role. The Fed “suppressed the yield curve and made it very clear to the banking industry that you would do this for a considerable period,” said Thomas Hoenig, former president of the Federal Reserve Bank of Kansas City and former vice chairman of the FDIC. “So bankers are making decisions based on that message and based on that policy, and they fill their portfolio up with government securities of varying maturities, and they say they’re going to hold them to maturity.”
Silvergate and SVB may have been particularly susceptible to the change in economic conditions because they concentrated their businesses in boom-bust sectors. With companies in those sectors now moving assets elsewhere in the financial system, the nature of those risks may shift, said Saule Omarova, a professor of law at Cornell University who was nominated to run the Office of the Comptroller of the Currency in 2021.
That suggests the need for regulators to take a broader view of the risks in the financial system. “All the financial regulators need to start taking charge and thinking through the structural consequences of what’s happening right now,” she said.