Commentary: Silicon Valley Bank crisis — where do we go from here?

Many are calling the recent collapse of Silicon Valley Bank, Signature Bank, and Silvergate Bank as a 2008 bailout deja vu. But except for another hurried backstop by the U.S. Treasury, the Federal Reserve Board and the Federal Deposit Insurance Corporation, the similarities to the 2008 financial crisis may just end there. This time around, there was no nationwide housing downturn or mortgage crisis creating undue stress to the U.S. and global financial system. In the words of Federal Reserve Vice Chairman Michael Barr, "this was a textbook case of (bank) mismanagement."

The impact of SVB's bankruptcy may not have been as far-reaching as the 2008 crisis, but a contagion effect had nevertheless ensued.

Today, instead of the mortgage sector, disruptions by the digital asset and other venture technologies threatened to upend domestic financial stability. Rising interest rates created liquidity problems for those banks that bet the wrong way.

The 2023 SVB crisis reflects new risks not seen in 2008. The digital asset sector has proven to be a volatile funding source for banks. The failures of Signature Bank and Silvergate Bank both underscore the implications to financial stability for banks servicing digital asset customers.

Recent data from the New York Federal Reserve point to the overall volatility of digital assets relative to traditional assets during normal economic cycles. Periods of extreme price swings to the value of assets for these companies invariably impact and create undue uncertainty to institutions that service them.

Even more glaring in the wake of the two bank failures is the lack of a strong supervisory and regulatory framework that effectively measures the financial vulnerabilities of the digital asset ecosystem. The novel risks and interconnections to the traditional financial system will need to be a strong focus for both legislative and regulatory supervision. Metrics for financial stability risk are overdue.

What has become quite clear by the testimonies of the FDIC, the Federal Reserve and the U.S. Treasury to the Senate Committee on Banking, Housing and Urban Affairs on March 28, 2023 suggests extending similar capital and stress testing standards required by Systemically Significant Financial Institutions to the regional banks with assets of $100 billion and more. But it's time to think outside the box. A more dynamic risk management approach that measures crypto-related liquidity risks is warranted vs. calculating macroeconomic worst-case scenarios on firm capital ratios. Regional banks also need to monitor more closely funding volatility from their depositor base, sector concentration and exposures and contingency funding in the event of a liquidity crisis.

If lax mortgage underwriting standards undermined the big banks during the 2008 financial crisis, overreliance on uninsured deposits to fund short-term needs was the equivalent in 2023. SVB topped the charts with an estimated 90% total uninsured deposits to total deposits. Signature Bank followed with similar exposure to uninsured deposits. The long existing practice by the FDIC of providing up to $250,000 deposit insurance was insufficient to cover larger depositors. The Biden administration's knee-jerk reaction to cover all depositors will come at a cost.

In the aftermath of the three bankruptcies, most taxpayers were left wondering who was going to ultimately foot the bill. FDIC Chairman Martin Gruenberg in his March 28 Senate Banking Committee testimony indicated that "any losses to the FDIC's Insurance Deposit Fund as a result of uninsured deposit insurance coverage will be repaid by a special assessment on banks as required by law." His statement goes on confirming the FDIC's authority to impose the assessment.

The Boards of the Federal Reserve and the FDIC had unanimously recommended to Treasury Secretary Janet Yellen, and in turn, President Joe Biden for the FDIC to invoke the Federal Deposit Insurance Act. The determination of systemic risk allowed the FDIC to invoke their emergency risk authorities under the FDI Act to protect all depositors and complete the SVB and Signature Bank wind-down.

The immediate depositor rescue may quell any investor or market uproar, but the long-term implications may prove forthcoming. The "special assessment to banks" portends of some looming banking cost that will ultimately be passed on to the public. Shareholders lost their investment and unsecured credits took losses.

Speculation is running high that new legislation is underway to remake deposit insurance. There has been no agreement on both sides of the aisle to date. However, one thing is for sure: The recent crisis has turned the spotlight on small depositors vs. large depositors that can be classified more as investors.

Crypto company Circle was found to maintain $3.1 billion of deposits at SVB. The most likely result of the legislation would move away from the current $250,000 maximum threshold. Instead, a new federal insurance framework creating deposit insurance tiers based on deposit size is anticipated. A sliding scale of bank fees related to deposit size may be expected to further differentiate various classes of depositors. Private insurance for the largest depositors has not been ruled out.

Lawmakers have been unapologetic in their criticism of the banking regulators and question the adequacy of regulatory controls. Democratic leaders, most especially, argue that the passing of the Economic Growth, Regulatory Relief, and Consumer Protection Act of 2018 eased financial regulations imposed by the Dodd-Frank Wall Street Reform and Consumer Protection Act.

The Economic Growth, Regulatory Relief, and Consumer Protection Act effectively raised the threshold from $50 billion to $250 billion under which banks were deemed too big to fail. Both SVB and Signature Bank fell below the $250 billion threshold, but their bankruptcies demonstrate the impact to the financial system.

If indeed the banks' collapse was due to mismanagement and not statutory failure, then the solutions may lie in more heightened asset and liability risk management. Renewed focus on concentrations, capital, liquidity, and interest-rate risk are some lessons learned. Special attention to duration risk to a bank's portfolio in an environment of rising interest rates is critical.

The FDIC Quarter Banking Profile for the fourth quarter of 2022 (published this February) highlighted key banking industry weaknesses resulting from unrealized losses on investment securities brought by rapid increases in market interest rate. Sudhir Jain, former National Futures Association exam director and currently managing director at Patomak Global Partners said, "When SVB liquidated its available-for-sale portfolio to meet deposit withdrawals, the market took note creating a bank run. With remaining assets locked in illiquid loans and hold-to-maturity securities, SVB's on-hand liquidity was insufficient. Liquidity, not solvency, was the key issue here."

There is no fail-safe insurance in preventing bank failures. The recent growth of innovation technology-related banking services and evolving market dynamics presents a constant challenge to regulators. Implementing a planned and contained resolution for banks with $100 billion and above are new considerations.

Amy Poster is a risk, regulatory, and governmental affairs consultant in banking and asset management and served as a senior policy advisor to the United States Treasury Special Inspector General-Troubled Asset Relief Program, or SIGTARP, during the 2008-2010 global financial crisis. This content represents the views of the author. It was submitted and edited under Pensions & Investments guidelines but is not a product of P&I's editorial team.