The recent collapse of two large regional banks, and the expedited sale of Credit Suisse due to similar challenges, have left many in the financial services industry uncertain about the future. What should we understand about what happened and what it might mean for the future of finance?
What Happened?
As everyone has now read about repeatedly, SVB collapsed due to a “run on the bank” involving customers withdrawing (or attempting to withdraw) their funds simultaneously. The run was prompted by fears that SVB could not honor withdrawals due to the decline in market value of long-term treasuries and other long-term assets. The decline in the value of these assets occurred due to the rise in interest rates over the past year, which has caused fixed income investments with lower interest rates to have a lower market value. Signature Bank was shut down by the New York Department of Financial Services and the Federal Deposit Insurance Corporation (FDIC) due to related concerns. At the time of the SVB collapse, the FDIC followed its protocols regarding the shutdown of a depository institution that is not subject to a systemic risk exception. This included shutting down SVB on Friday, March 10th, establishing a new national bank, and guaranteeing access on Monday, March 13th, for any deposits up to the FDIC insurance limit. That limit is presently $250,000 per depositor. As to any amounts in excess of $250,000, the FDIC noted an advance dividend would be paid later that week based upon assets sold, and the remaining amounts would be handled through the FDIC’s receivership process.
To put it mildly, SVB depositors and commentators exploded on social media regarding the potential loss or delayed access to significant amounts of business capital, with some noting various companies would be unable to make payroll without access to the funds in their operating accounts. As we now know, the Treasury, Federal Reserve, and the FDIC invoked the systemic risk exception for both SVB and Signature Bank on Sunday, March 12th, which enabled the agencies to guarantee all deposits of the banks. This exception is designed to enable federal agencies to prevent the adverse economic consequences of broader financial instability.
The federal reserve also established a new Bank Term Funding Program designed to provide liquidity to banks. The program allows banks to borrow money secured by U.S. treasuries, agency debt, mortgage-backed securities, and other qualifying assets as collateral. The program also allows banks to borrow funds based upon the par value of the assets, not the lower market value.
The Crystal Ball: What (Regulations) Will Come?
The U.S. banking system functions on consumer confidence that the money will be there when depositors need it. The past week introduced what some have called a new variation on a longstanding risk: a social media-fueled bank run. FDIC insurance was designed to be the primary hedge against bank runs, but it proved inadequate in SVB’s case. This was in significant part due to the low level of FDIC insurance when compared to the capital required to operate a business and the concentration of deposits in a single institution by deposit holders. These facts lead to a couple of potential legislative changes.
First, lawmakers are already proposing bills to increase the FDIC insurance limits. Second, lawmakers and regulators will have to grapple with how to deal with what some have called a social media in connection with bank run. (It is worth noting, however, that some commentators minimize social media’s role in adding fuel to the fire.) The federal agencies’ response implies that they will backstop deposits well beyond the largest banks, but it is unclear where (and whether) the agencies could stop if smaller banks face financial difficulties as well. Although the present response is designed to prevent the agencies from needing to answer this question now by backstopping other regional depository institutions, policymakers will have to address what to do in the future if additional bank runs occur.
Regulatory agencies will likely also increase their focus on managing interest rate risk on depository institution balance sheets. Regulatory agencies have faced significant criticism for failing to detect what some refer to as an obvious balance sheet concern caused by the combination of demand deposits that can be withdrawn immediately and long-term government securities pledged to be held to maturity. In response, the agencies will likely increase the urgency of examinations and stress testing focused on the impact of rising interest rates on depository institution balance sheets.
Some lawmakers have already proposed restoring Dodd-Frank’s stress testing of banks above the $50 billion threshold after these standards were reduced several years ago. We will have to see how far the changes will go. Regulators can force depository institutions to amass a fortress-like balance sheet of short-term treasuries, but those assets pay lower interest rates. Likewise, those requirements only go so far before banking products start to become more expensive for customers and lawmakers call for lower-cost banking products.
