BPInsights: March 18, 2023

What’s Next After Silicon Valley Bank?

Silicon Valley Bank and Signature Bank’s failure raises questions about what went wrong and what the path of future bank policy looks like.

  • BPI’s view: These failures appear to reflect primarily a failure of management and supervision, rather than regulation, BPI said in a statement this week. The banks’ rapid growth, heavy exposure to interest rate risk and abnormally large share of uninsured deposits put them at serious risk. Interest rate risk management and asset-liability management are key focuses for bank managers and examiners, and unlike credit or liquidity risk, interest rate risk is not easily reduced to a formula. Regulatory tailoring under S. 2155 does not appear to have been a major factor in SVB’s or Signature Bank’s failure. Additionally, the resolution process for both banks seems to deserve scrutiny – the smoothest course of action for customers and markets would have been for the FDIC to find a buyer for SVB, as the Bank of England did for its British subsidiary. Yet that did not happen. The FDIC’s required failed-bank review will presumably shed light on the effectiveness of supervision and the resolution process.
  • Next steps: Fed Vice Chair for Supervision Michael Barr is leading a probe of the Fed’s supervision and regulation of Silicon Valley Bank. The FDIC Inspector General will also have to publish a failed-bank review as required by law. These efforts may elucidate more detail about what happened ahead of, and during, the collapse. The Department of Justice and SEC are also probing the collapse of SVB. Banks will face a special assessment to cover any losses to the Deposit Insurance Fund to support uninsured depositors. And the FDIC is planning another auction for SVB, after it failed to find – or failed to accept – a buyer on its initial try. 
  • Credit ratings: Silicon Valley Bank and Signature both had high credit ratings before their failures, according to the Wall Street Journal, casting doubt on the ability of ratings firms to predict impending disaster.
  • Big picture: The collapse has also triggered uncertainty about the future of deposit insurance, potential new requirements for mid-sized banks, the oversight of banks’ interest rate risk, the Fed’s rate path and the digital speed of the SVB bank run. 

Four Key Things

1. Large Banks Provide $30B in Deposits to First Republic

Eleven large banks — Bank of America, Citigroup, JPMorgan Chase, Wells Fargo, Goldman Sachs, Morgan Stanley, BNY Mellon, PNC, State Street, Truist and U.S. Bank — on Thursday announced they would provide $30 billion total in uninsured deposits to First Republic Bank to help the institution bolster its liquidity amid stock price volatility. “The actions of America’s largest banks reflect their confidence in the country’s banking system,” the banks said in a press release. “Together, we are deploying our financial strength and liquidity into the larger system, where it is needed the most. Smaller- and medium-sized banks support their local customers and businesses, create millions of jobs and help uplift communities. America’s larger banks stand united with all banks to support our economy and all of those around us.”

  • Regulator reaction: “This show of support by a group of large banks is most welcome, and demonstrates the resilience of the banking system,” the Treasury Department, Fed, FDIC and OCC said in a statement.

2. Credit Suisse Bolstered by Swiss Central Bank Loan

Credit Suisse rebounded from a drastic stock price drop after the Swiss central bank agreed to lend it up to 50 billion francs ($54 billion). Credit Suisse sparked investor fear after it identified material weaknesses in its financial reporting controls in its annual report.

3. The Fed’s Discount Window Lending: Explained

Federal Reserve lending increased sharply over the last week. The rise makes sense given recent events – this situation is exactly the scenario for which Fed lending programs were designed. On Thursday, the Fed released its weekly balance sheet data, the H.4.1. statistical release, available here. As shown in the rightmost column of table 1, the Fed was lending depository institutions $308 billion on Wednesday (excluding PPP loans), up from $5 billion a week earlier. The lending took three forms, regular discount window lending (“primary credit”), lending to the bridge banks the FDIC created for SVB and Signature and lending through its new Bank Term Funding Program.

Here are some key takeaways about the recent trends.

  • Primary credit: The Fed was lending banks $153 billion of primary credit on Wednesday. Primary credit is what is normally called discount window credit, and it is extended at the primary credit rate, what is normally called the discount rate. BPI’s new blog post explains more about how it works. This credit is only available to financially sound depository institutions (at least adequately capitalized and with a CAMELS 3 rating or better).
  • Bridges: One noticeable point in the data is that on Wednesday, the Fed was also lending $143 billion to the bridge banks the FDIC established for SVB and Signature. The loans may largely be discount window loans that had been extended to the banks before they failed.
  • New program: The Fed was only lending $12 billion under its new “Bank Term Funding Program” on Wednesday.  The Fed announced the program on Sunday.  Eligible borrowers are commercial banks and other insured depository institutions that are eligible for primary credit (that is, they are financially sound). The program extends one-year term loans to DIs at the one-year OIS swap rate plus 10 basis points (a fixed rate). The loans are collateralized by Treasuries, agency debt and agency MBS. What makes the program different is that the Fed will lend up to the full par value of the securities. Unlike many of the Fed’s emergency programs, the loans are extended with recourse. That means that if the borrower defaults and the collateral doesn’t cover the loan, the Fed and Treasury can go after all the assets of the defaulted bank, joining other general creditors, although behind depositors. Borrowing under this new facility may be low because banks that need credit are borrowing primary credit instead; they may prefer to borrow against the loan collateral they have prepositioned at the discount window, holding their government securities to meet other needs. Or they could just be more familiar with regular discount window credit.

To learn more about these various lending facilities, read BPI’s new blog post here.

4. The LCR Was Not Designed for This

Post-mortem analysis of Silicon Valley Bank’s demise is rife with “what if” speculation. Some have questioned whether SVB would have met the liquidity coverage ratio, a requirement from which it was exempt under the S. 2155 tailoring law. It’s not possible to know for sure but the answer appears to be yes. 

For most banks, the LCR tells you a lot about their ability to withstand a run:  it logically looks at what liabilities could run over a 30-day period and what assets could be sold to meet that run.  However, the LCR was never designed to measure interest rate risk – including massive interest rate risk of the type being run by SVB.  Basically, the LCR thinks of high-quality liquid assets (Treasuries, agency MBS) as good assets, because they can be sold easily.  SVB held a lot of those assets.  But they were long-dated and therefore came with significant interest rate risk.  

  • Not surprising: This result, explored in a BPI analysis, is no surprise, given that interest rate risk was the root cause of SVB’s failure. Its problem was not that it did not hold liquid securities like Treasuries or agency mortgage-backed securities – its problem was that those securities’ value sunk when interest rates rose. That’s not a problem the LCR is designed to catch.
  • Furthermore: SVB was subject to the Regulation YY internal liquidity stress tests, under which examiners reportedly require banks to make assumptions that are more severe than the LCR. These internal stress tests also require banks to project cash flow needs overnight, a more relevant timeframe than the LCR. Even if SVB had been subject to the LCR and had failed, it would probably have adjusted by increasing its holdings of longer-term Treasury securities, which would have exacerbated its interest rate risk.
  • Bottom line: The failure of SVB appears to be a failure of management and supervision, not regulation. SVB probably would have passed the LCR, and it was subject to stringent internal liquidity stress tests, but those stress tests are only as good as their implementation by bank management and oversight by bank examiners. And even if SVB had been required to maintain more high-quality liquid assets, that step may have amplified its troubles rather than resolving them.
  • Addendum: If SVB had been subject to the LCR for GSIBs rather than the LCR for regional banks as we assumed, for example, if it had foreign exposures greater than $10 billion, our point estimate is that they still would have passed, although it would have been closer.  The makeup of its deposits, especially the quantity of deposits from financial institutions, would matter even more. That said, given SVB’s business model, it presumably would have simply shifted some of its investments in agency MBS toward longer-term Treasuries or Ginnie Maes to achieve compliance. Every dollar switched would have raised HQLA 82 cents. SVB’s problem was taking on too much interest rate risk, a problem the LCR isn’t intended to identify or remedy.

In Case You Missed It

Global Perspectives on SVB

The U.S. government’s handling of the SVB failure elicited criticism from European financial policymakers, according to the Financial Times. Some officials, including in France and the U.K., disagreed with U.S. policymakers’ decision to invoke the systemic risk exception for a bank of SVB’s size, according to the article. The collapse has motivated European regulators to speed up work on bank resolution rules, according to a separate Financial Times piece.

Lawmakers Urge Better Rollout of Anti-Money Laundering Reform

A bipartisan group of senators, including Sens. Sheldon Whitehouse (D-RI) and Chuck Grassley (R-IA), called on Treasury’s FinCEN to improve its implementation of the Corporate Transparency Act, a key anti-money laundering reform law. The senators recommended adjustments to FinCEN’s rulemaking to ensure the law hews to its Congressional intent and targets financial crime and shell companies. “While we appreciate the time and effort you have put into the implementation of this critical law, we have concerns that this proposed rule strays from congressional intent and erects unnecessary and costly barriers to accessing beneficial ownership information that risk undermining the utility of the beneficial ownership directory,” wrote the senators.  “We encourage you to revise the rule to ensure it tracks closer to the text of the statute, remove excessive barriers to accessing the directory by authorized recipients, and enhance the utility of the directory.” See the letter with the full recommendations here.

The Crypto Ledger

U.S. prosecutors and the SEC were probing Signature Bank’s vetting of crypto clients before the New York bank failed, according to Bloomberg. The investigations centered on whether Signature took sufficient steps to detect potential money laundering. Here’s what else is new in crypto.

  • SBF: Sam Bankman-Fried received more than $2 billion in transfers from FTX entities, according to bankruptcy court filings cited by the Financial Times. Bankman-Fried and close associates transferred $3.2 billion in total to personal accounts in the form of “payments and loans”, according to the article.
  • Mixer: U.S. and European authorities shut down crypto platform ChipMixer, accusing its operator of laundering more than $3 billion. The total includes $700 million allegedly stolen by North Korean hackers.

BofA Launches Online Marketplace for Women Entrepreneurs

Bank of America recently launched a new online marketplace for women entrepreneurs that provides them access to new markets and opportunities for customers to support their businesses. The initiative was launched in partnership with Seneca Women and features a range of women-owned businesses from around the world.

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The views expressed do not necessarily reflect those of the Bank Policy Institute’s member banks, and are not intended to be, and should not be construed as, legal advice of any kind.