The SVB collapse: Social media driven bank run exposes regulatory gaps, but what next?

Introduction

The collapse of Silicon Valley Bank (SVB) – the 16th largest bank in the United States with US$212bn in assets – has led to a level of concern in financial markets across the world not seen since the Global Financial Crisis 15 years ago.

SVB is the second largest bank failure in United States history – with the largest being Washington Mutual at the height of the GFC in 2008.

But SVB’s collapse is far from what some have labelled a new ‘Lehman Brothers moment’.

SVB faced a unique set of circumstances. Its customers comprised almost exclusively tech companies, start-ups and companies funded by venture capitalists. Those are the very entities that have been among the hardest hit by the current economic downturn – and with equity and capital markets drying up, and tightened lending conditions in financial markets, there has been a rush on deposits by these entities in recent months.

To meet these calls on deposits, SVB was forced to sell some of the highly rated and liquid Treasury bonds and mortgage-backed securities that comprised a substantial portion of its asset portfolio.

This was nothing out of the ordinary by itself. However, SVB had purchased its bonds and securities at a time when rates were low and prices were high. But rapid increases in official interest rates have caused the market price for bonds and securities to fall (reflecting the inverse relationship between bond prices and yields), even though the credit quality of those bonds and securities remains very robust.

SVB’s forced selling of bonds and securities led to a US$1.8bn loss from a US$21bn sale.

Up until realising that loss, SVB had been able to take advantage of accounting rules in the United States under which, so long as banks intend to hold bonds to maturity, they do not need to write down the value of the bonds on current market rates in their reported assets.

Further, there are regulatory concessions in the United States under which smaller banks are not required to set aside capital for any mark-to-market unrealised paper losses they face on bonds whose prices have dropped with rising interest rates.

Compounding this even further in SVB’s case is that it seems it did not adequately hedge its low yielding bonds and securities against the risk of rising interest rates.

When its unrealised bond and securities losses crystallised, and SVB was unable to raise additional capital to offset the losses, panic set in. In perhaps the world’s first social media driven bank run, depositors sought to pull US$42bn in a single day as news of ‘imminent danger’ and ‘mass losses’ and related memes spread like wildfire across Twitter and other social media outlets.

The regulators acted swiftly. First, the California Department of Financial Protection and Innovation seized control of SVB on Friday 10 March and placed it into Federal Deposit Insurance Corporation (FDIC) receivership. Then, on Sunday night, the risk of further rapid contagion losses for tech firms and start-ups was addressed when the United States Treasury, Federal Reserve and the FDIC announced that all SVB deposits will be guaranteed beyond the US$250,000 insured amount per customer.

Further, the Federal Reserve announced a new Bank Term Funding Program that will offer loans of up to one year for banks and other financiers in return for high-quality collateral pledges. This will act as a backstop for all deposits, both insured and uninsured, with the aim to protect the stability of the United States financial system.

Indeed, in the absence of this Funding Program, other SME lenders may have experienced their own risk of collapse – given the same systemic issues (difficulty borrowing in wholesale lending markets and heavy unrealised losses on bonds and securities) and regulatory gaps faced by SVB, and the prospect of similar bank runs as customers sought to diversify their deposits and move funds into ‘safer’ financial institutions.

What next from a global perspective?

The move from United States regulators might see a return to broad-based deposit guarantee schemes – similar to those introduced during the GFC – in other countries as global regulators seek to secure the position of their banks and the stability of their financial systems.

That said, in other countries there are different regulatory settings in relation to the bonds and securities that comprised SVB’s assets – for example in Australia where banks and other authorised deposit-taking institutions are required to hold sufficient regulatory capital against credit risk exposures. In many of these other countries, banks also tend to have a greater spread of depositors across industries and sectors, as distinct from the concentration within the tech and start-up sector seen in SVB’s case. As a result, the need for broad-based guarantee schemes may not be as significant.

As the dust settles from the SVB tempest, it will be important to look more closely at any risk failings and the regulatory weak spots that contributed to the collapse, and for global regulators to work closely together to align prudential standards that respond to heightened financial and economic risks as the world navigates ongoing headwinds over the next 12 months.

Since this article was first published, the regulatory and commercial situation has, and continues to, rapidly evolve. As at 14 March 2023, the Federal Deposit Insurance Corporation has transferred all deposits of SVB (both insured and uninsured) to a newly created bridge bank, and has reiterated that all deposit holders will be made whole.