Why did Silicon Valley Bank explode when it was clearly an "overachiever" in the eyes of regulators?

Release Time：2023-03-13

Readers familiar with the 2008 financial crisis may find that Silicon Valley Bank was given the same playbook as big commercial banks such as Northern Rock and Hbos, which suffered runs at the time.

To sum up the collapse of Silicon Valley banks, depositors' short-term deposits (a lump sum of money that can be withdrawn at any time) were invested in long-term bonds such as MBS and US Treasuries (a lump sum of money that is less liquid). As the Fed raised rates, its bonds soured and large investments turned into unrealized losses, forcing it to tap the markets for funding. Depositors who caught the warning signs withdrew $42 billion a day in a panic, triggering a liquidity crisis.

Ironically, less than a month ago, Silicon Valley Bank made Forbes magazine's "2023 Top 100 Banks in the United States" list, ranking fifth in California and 20th in the United States for outstanding profitability. Silicon Valley Bank, which has complied with all regulatory requirements, has a reputation for sound operations and has a portfolio of what are traditionally considered the safest assets. But risks flare up.

So why is the same crisis happening again? How did regulators' top students explode?

Smaller banks are more likely to evade regulation

In the wake of the financial crisis, international regulators came up with the Basel III rules, which regulate the banking industry in two main ways.

The first is the liquidity coverage ratio (LCR), which measures emergency funding capacity. To ensure that commercial banks, when faced with severe liquidity pressure, are able to maintain sufficient quality liquid assets without obstacles to realization. The liquidity pressure here refers to the scenario in which banks face a drying up of wholesale funding and a run on some small and corporate deposits.

Liquidity coverage ratio = high quality liquid assets held by the bank/the amount of capital outflow under liquidity pressure in the next 30 days.

Under Basel III rules, banks must have a liquidity coverage ratio of more than 100 per cent, ensuring a 30-day "life span".

The second measure is the net stable funding ratio (NSFR), which is intended to measure structured finance liquidity. It calculates the ratio of two sides of a bank's balance sheet, each weighted for liquidity risk.

The weighting on the asset side is determined by how easy it is to realize the assets. For example, short-term US Treasuries get 100 per cent weighting, while long-term corporate bonds get 50 per cent and loans zero.

The liability side is weighted according to the likelihood that creditors will want their cash back immediately. As a result, overnight repos are weighted 100 per cent and retail deposits 90 per cent. The weight of long-term bonds and deposits is 0.

Under Basel III, the ratio of assets to liabilities must also be above 100%.

The problem, however, is that some smaller US regional commercial banks, which rely heavily on borrowing short and lending long for profit, do not want to be subject to Basel rules. The banks spent a lot of money lobbying the US government to relax regulations. In the end, the Fed opted to "catch the big and let the small go", focusing on the "large international banks", with banks with total assets of $25m or more subject to prudential supervision requirements.

Here's an excerpt from Silicon Valley Bank's latest 10-K report:

As a bank, our liquidity is under scrutiny by regulators. Because our total fixed assets are less than $250 billion, our short-term wholesale financing is less than $50 billion, and our cross-border transactions are less than $75 billion, we are not currently subject to the Federal Reserve's LCR and NSFR requirements.

Silicon Valley Bank has complied with all regulatory requirements

Although Silicon Valley Bank is the 16th largest bank in the US by balance sheet size, it is subject to very limited regulation under US law - a pure oversight on the part of US regulators. As it argued in its 10-K report, a bank is only required to comply with the NSFR and LCR rules if it has more than $50bn in short-term wholesale funding, and the liability side of Silicon Valley banks is mainly deposits from corporate customers.

It neither broke the law nor dabbled in risky derivatives investments. According to Zerohedge, a financial blog, Silicon Valley Bank is a boring, conservative bank whose deposits grew to $189 billion in 2021 thanks to the tech bull market. Silicon Valley banks invested their growing deposits in some of the safest assets in the world (until the Fed raised rates) : Treasury bonds, federal agency debt and mortgage-backed securities.

It was a model of scripted banking management: in the midst of the technology bull market in CDS, it complied with all the regulators' demands and chose to lie down safely.

The only way a bank could have accumulated risk is if it thought it was doing so without a shred of risk.

Massive maturity mismatches have occurred right under the Fed's nose. As the assets and deposits of Silicon Valley Bank increased rapidly, the floating losses on the bond investments in the notes to the financial statements also increased significantly. And it is not just the recently failed Silicon Valley banks that are at risk of big losses. Across the industry, unrealized losses on securities stood at about $620 billion at the end of last year, according to the Federal Deposit Insurance Corporation. The negligence of regulators and bank executives has accumulated into a growing hole.

With the Fed's rescue, bank depositors are safe for now, and Wall Street analysts believe regulators may revisit liquidity rules in the wake of this crisis. But when will the next crisis come? No one can tell.

Risk warning and disclaimer clause

The market is risky and investment needs to be cautious. This article does not constitute personal investment advice and does not take into account the particular investment objectives, financial situation or needs of individual users. Users should consider whether any opinion, opinion or conclusion in this article fits their particular situation. Invest accordingly at your own risk.