Economists: No need to fret over recent bank collapse

Some people are worried about the safety of their bank accounts after the recent failures of some financial institutions in the Silicon Valley. But economists generally agree there is no need for widespread panic.

“The U.S. banking system — as we know it today — has been following the same basic set of rules for a half-century or more, and the way banks work as financial intermediaries is pretty transparent,” said Scott Gilbert, a professor and Economics Program Coordinator at SIU and on-time employee in the Research Department at the Federal Reserve of San Francisco. “…If policy-makers had a desire to reduce public panic about banks, an effective policy may be to assure the public that the built-in safety mechanism of deposit insurance remains secure.”

There is a world of federal policy between a normal day at the bank and the classic bank-run lines that appeared outside of Silicon Valley Bank (SVB) this March.

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Between 2020 and 2021, the COVID-19 pandemic blazed across the United States and the country began to move school, work and most non-essential interactions online. This caused a surge in the tech sphere, spawning dozens of Silicon Valley startups with a great deal of liquidity due to influxes of cash from investors and short term loans. This presented SVB, which specialized in startups, with a problem. Many of the new tech start-ups it serviced required no new loans, depriving the bank of income. So, with money deposited by cash-laden start-ups, SVB decided to invest in long term securities, particularly government securities, widely seen as the safest of investments.

Because the federal government is far less likely to fail than a bank, there is almost no chance of losing the money deposited. However, with the recent increase in the Federal Reserve’s interest rates, which recently rose from near zero to 5%, federal bonds had become far more lucrative making the market price of SVB’s government bonds much lower.

If SVB were to continue to hold the assets in the long term as they had initially planned, they would eventually have seen all of the money they invested paid back by the federal government, once the bonds “matured,” as well as profits in the form of  interest payments about twice a year. However, should customers suddenly start demanding their deposits back enmasse, having too large a percentage of its deposits caught up in long-term bonds would be a recipe for a serious disaster.

Unfortunately, the rise in interest rates hadn’t affected the bank in a vacuum. The customer base of the bank, comprised largely of ambitious start-ups that had flourished in the era of near zero interest rates, was suddenly dealing with more cautious investors and loans which were far more expensive. They began to draw more heavily on money from their accounts to compensate, roughly around the same time.

Suddenly, SVB needed to sell its government securities before they matured in order to give customers their deposits back in cash, leaving the bank at the mercy of far lower market prices than those the bonds were initially purchased at. SVB sold 21 billion dollars of securities, resulting in a loss of 1.8 billion dollars. This, combined with an effort to sell 2.25 billion dollars of stock to investors to shore up their losses, made the company look as if it was expecting a major dip in stock prices, causing its stock price to crater.

Needless to say, this didn’t inspire confidence in depositors, resulting in a “run” on the bank, meaning many customers attempted to get their money back at the same time, causing a liquidity crisis. SVB simply didn’t have cash on hand to pay back all of its clients.

Depositors attempted to take almost a quarter of the bank’s deposits back in a single day, resulting in the failure of the stock sale, and a failed attempt to sell SVB as a whole to a competitor with enough liquidity to deal with the crisis. SVB was taken over by the Federal Deposit Insurance Corporation, whose mission is to maintain public confidence in banking by keeping banks stable and insured by up to $250,000 per account.

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In theory, the federal government’s regulators should have foreseen the vulnerability of SVB. The Dodd-Frank Wall Street Reform and FDIC Consumer Protection Act, passed by then-President Barack Obama, required yearly stress tests of banks and established orderly liquidation procedures in the event of a bank collapsing (meaning that depositors were likely to get their money back eventually). It also limited the amount of risk that banks large enough to be considered “systemically important” were able to take on.

The bill was widely thought to improve the stability of the banking system in the wake of the Great Recession in 2008, but its passage was mainly partisan, with only a handful of Republican votes saving it from filibuster. The main criticism leveled against the bill was that it stifled the growth of small community banks and prevented the growth of the economy from achieving its maximum potential.

Because of this line of reasoning, Congress (with bipartisan support) and former President Donald Trump passed the The Economic Growth, Regulatory Relief and Consumer Protection Act in 2018, which repealed certain elements of the Dodd-Frank reform, including the threshold at which banks would be subject to stricter regulations. Instead of being regulated after controlling $50 billion of assets, banks would now only fall under the strictest regulations at $250 billion of assets, which the SVB fell just shy of at $209 billion in assets according to a Washington Post article. Essentially, with reduced regulations, banks are able to invest more of customers’ money rather than keeping it in stock for a potential crisis, resulting in more profit.

Notably, this reduction in regulation came at a time when banks were making record profits. In the first quarter of 2018, the industry made approximately $56 billion across all ensured institutions, according to the FDIC.

Although, admittedly, the federal government didn’t use taxpayer money when it bailed out SVB’s customers instead relying on a premium charged to the rest of the banking system, the regulatory bodies that should have been stress testing SVB for situations such as a sudden hike in interest rates are under some scrutiny.

“You know, the potential for a shortfall in terms of what the insurance program could do to cover sudden draws on it probably does call for and perhaps now they will go and do some more, as you say, stress testing it for the especially these situations with giant accounts, because maybe they are more preventable,” Gilbert said. “To me, it makes perfect sense at a bank where many depositors have exceeded the quarter million mark for their checking and savings accounts.”

On the other hand, Tim Marlo, a clinical associate professor for the SIU College of Business and supervisor of the Saluki Student Investment fund (which allows students to manage the SIU Foundation’s money as if they were working at an investment firm), said he’s unconvinced the bank could have overcome the problem, even with more regulation.

“There were many factors ranging from cryptocurrency collapsing to rising interest rates that created the collapse of SVB,” Marlo said. “Similar to financial regulation cycles, economic cycles repeat themselves. Yes, there will be a recession sometime in the future. However, how bad it will be or when it will even occur are not known yet despite wild speculation.”

According to Gilbert, there are two schools of thought on the issue of bank regulations: those who argue that less regulation will result in increased efficiency for businesses causing them to thrive and provide better services at lower rates as well as increased employee wages, and those who prioritize the issue of customer safety and the public’s confidence in banks.

“That second school is where some economists will then say ‘hey efficiency isn’t everything.’ Boosting up the GDP [gross domestic product] is only one measure of economic welfare, and our happiness and way of life and how we feel about that,” Gilbert said. “So things like the externalities from pollution, bad things that happen when we’re just efficient or seemingly efficient in terms of output, are some things that economists, at least a group of economists, will care about. And other things, too, like even issues of inequality. If we just let businesses duke it out, often what happens is there’s just a few very rich businesses and the people that own them are really rich, and then we have a whole bunch of poor people.”

According to the Yale School of Management, the liquidity coverage ratio (LCR) rule, originally from the Basel III reform (an international agreement designed to prevent another international financial crisis) and later adopted as a rule by federal regulators in 2014, would have helped prevent the SVB collapse if Trump hadn’t repealed it.

The LCR rule required banks to hold on to high-quality liquid assets (HQLA) greater than or equal to their 30 day net cash flow if they either held $250 billion or more in assets, or had at least $10 billion or more dollars in exposure to foreign markets. SVB bank would have qualified on the latter criteria, but, because it was allowed to go unregulated, it held only 75% of its monthly cash flow in liquid assets in 2022, according to Yale. Millions, if not billions of dollars, could have potentially forestalled the disaster long enough for the bank to sell itself.

SVB would also have been required to report more data about its liquidity if Obama-era banking laws were in place.

The Biden Administration has published a fact sheet advocating for greater regulation of banks after the collapse of SVB, which it claims also suffered from inadequate capital to absorb unrealized losses from all of the long-term securities it had invested in, as well as a lack of a “living will,” or a plan for the smooth liquidation of a bank in the event of its failure.

Banks and credit unions local to Carbondale – though possibly less regulated than they were pre-2018 – say that they are not comparable to SVB in their investment strategies and their customer bases.

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