Thierry Philipponnat, Chief Economist at Finance Watch said:
“In the US, like in the EU, even small banks have become too-big-to fail. Despite claims from politicians on both sides of the Atlantic never again to bail-out failing banks with public money, it has happened a significant number of times in the EU in recent years and it happened last week in the US.
It’s ironic that EU politicians should be blaming, rightly, the US for not applying the Basel III framework to their small and medium size banks at the very moment they’re discussing an EU banking package that diverges significantly from Basel III and lowers prudential requirements for EU banks, large and small.
The sad reality is that in America and Europe, bank lobby rhetoric on why capital requirements are supposedly ‘harmful’ wins the hearts of policymakers working on banking regulation, until they are brought back to the real world by the next crisis.”
Why it happened:
SVB risk management failures:
- On the liquidity risk side, SVB had a total of over $130 billion of demand and money market deposits from a very homogenous and prone to herd-like behaviour client base – tech and life science businesses – which could be withdrawn anytime and were not backed by an appropriate amount of cash and securities which could be liquidated without realising losses. Such deposits are generally considered as “not sticky”, i.e. banks have to take into account that there could be a high rate of withdrawal.
- Asset-liability management of the bank did not work well either. Despite large volumes of sight deposits, only $26 billion of SVB´s asset portfolio were classified as available for sale (AFS), whilst over $91 billion were held to maturity (HTM), meaning that they are not repriced or marked-to-marked daily and possible losses of market value are not immediately visible.
- Interest rate risk in the HTM portfolio was not adequately hedged. The mounting unrealised losses on this HTM portfolio became apparent at the end of 2022 when the Federal Reserve (Fed) started to raise interest rates, but the bank did not take appropriate action to handle the growing impairment. Moreover, in its annual report dated 31 December 2022, the bank stated that the decision was taken not to transfer any securities from AFS to HTM portfolio despite an updated Financial Accounting Standards Board (FASB) standard which allowed it to do so (Some people did however, including SVB’s former chief executive, Gregory Becker, who exercised options in late February and sold shares worth about $3 million). Eventually, there was no sufficient stressed capital buffer to withstand possible losses due to interest rate risk in the HTM book.
Regulatory failures:
- The US deregulatory agenda and decision not to apply Basel III requirements to small and medium size banks have played a very significant role. Following the Regulatory Implementation of the Economic Growth, Regulatory Relief and Consumer Protection Act in 2018, the Fed relaxed its rules and lowered requirements on “smaller” banks in accordance with the “proportionality principle”. In particular, banks with assets below $250 billion were freed from the regulatory stress testing requirement. As of year-end 2022, SVB reported total consolidated assets of $211.8 billion. Further, as per the US regulation, SVB was not required to follow Basel liquidity requirements, such as compliance with liquidity coverage ratio (LCR) and net stable funding ratio (NSFR) requirements.
Finance Watch perspective:
Sound risk management, supervision and capital rules are essential for stability.
The message is not new, yet the failure of SVB reinforces the basic prudential principles, which have received less and less attention in the years after the 2008-2009 crisis. Regulators and supervisors should not be complacent, as calls of the banking sector for more lax prudential rules mount using arguments of improved soundness and capitalisation following the post-crisis reforms. Quite to the contrary, in the post-crisis years, the complexity of the financial system increased significantly and new risks emerged – such as digitalisation and operational resilience, growth of the shadow banking sector, interconnectedness of financial markets and associated vulnerabilities, in particular in the liquidity space. The post-crisis years of extremely low interest rates and ample provision of liquidity by central banks also led to the build-up of risks in the system. The SVB case is an example of what happens when they materialise as we experience a change in monetary stance.
The proportionality principle in prudential regulation should not be abused.
The collapse of SVB is a prime example of what happens when it is. The message is essential as the EU co-legislators have recently entered into negotiations on the prudential reform for the EU banking sector (Capital Requirements Regulation/Directive). Application of the proportionality principle is an important part of debate on prudential rules. Just because a bank is smaller does not automatically mean it is less risky. Legislators and regulators have become complacent about systemic risk. Contagion effects in the highly interconnected financial system means reconsidering how we define a systemically important bank.
Reliable resolution frameworks and deposit insurance are vital to protect taxpayers.
Finally, the collapse of SVB is a timely reminder that reform of the EU Crisis Management and Deposit Insurance framework is overdue. The introduction of the EU Crisis Management and Deposit Insurance framework following the global financial crisis was an undeniable step forward. The existing framework may now be put to the test and whether it is sufficient remains in doubt. EU policymakers and regulators need to concentrate their efforts on the rigorous and consistent implementation of the existing bank recovery and resolution rulebook.
To arrange an interview with Thierry Philipponnat, Chief Economist at Finance Watch, please contact Alison Burns at alison.burns@finance-watch.org or call on +32 (0)471577233
About Finance Watch
Finance Watch is an independently funded public interest association dedicated to making finance work for the good of society. Its mission is to strengthen the voice of society in the reform of financial regulation by conducting advocacy and presenting public interest arguments to lawmakers and the public. Finance Watch’s members include consumer groups, housing associations, trade unions, NGOs, financial experts, academics and other civil society groups that collectively represent a large number of European citizens. Finance Watch’s founding principles state that finance is essential for society in bringing capital to productive use in a transparent and sustainable manner, but that the legitimate pursuit of private interests by the financial industry should not be conducted to the detriment of society.
