Lessons from the Collapse of SVB

On March 10, Silicon Valley Bank (SVB) in the United States failed. Bank failures can result from various causes, including liquidity problems such as asset-liability maturity mismatches and financial soundness problems caused by deteriorating performance, but the direct cause of SVB’s failure was a massive bank run.

On March 9, the day before SVB’s collapse, withdrawals totaled $42 billion, and on March 10, deposit withdrawals reached $100 billion, bringing total withdrawals over the two days to $142 billion. This amounted to about 81% of SVB’s $175 billion in deposits at the end of last year. Once the bank run began at SVB, the Federal Reserve immediately decided to shut down the bank.

During the prolonged low-interest-rate environment that persisted for quite a long time after the 2007–2009 financial crisis, many U.S. banks invested surplus funds in relatively high-yield bonds. In general, short-term U.S. Treasury securities, medium- to long-term bonds with longer maturities, and Agency MBS (mortgage-backed securities), which are publicly guaranteed products, are regarded as the safest assets with a low probability of default. However, the sharp decline in bond prices caused by the rapid interest rate hikes that began last year was the main cause of SVB’s losses.

At the end of 2022, SVB held $120 billion in bonds, equivalent to 69% of its deposits and 55% of its total assets, more than twice the average bond holdings of U.S. banks. Unlike ordinary commercial banks whose main customers are individual clients, SVB’s primary customers were tech companies located in Silicon Valley.

Because large amounts of capital flowed in from tech companies during the low-interest-rate period that continued from 2010, SVB grew rapidly, and most of its abundant funds were invested in bonds. Accounts with balances under $250,000 made up only 3% of the total at SVB, meaning that nearly all accounts were owned by corporate clients with large deposits exceeding $250,000.

However, because corporate deposits are large and are not protected by deposit insurance, they are more sensitive to price fluctuations than individual deposits, so funds tend to leave more quickly in times of crisis. As bond prices fell sharply, SVB sold $21.5 billion worth of available-for-sale securities, including Treasury bonds and Agency MBS, and carried out a $2.25 billion capital increase, causing its stock price to plunge. Sensing the crisis, customers then attempted mass withdrawals.

Immediately after the SVB incident occurred, the federal government ordered the bank’s closure and initially announced that it would pay out only up to the $250,000 deposit insurance limit. But the next day, it reversed that announcement, declaring that all deposits would be fully guaranteed regardless of the insurance limit and that it would lend funds to financial institutions facing liquidity shortages.

As the federal government took on SVB’s large-scale losses, the situation was turned into one requiring public funds. Previously, in November 2021, the Federal Reserve had pointed out the possibility of balance-sheet problems at SVB stemming from benchmark interest rate hikes, but it failed to respond appropriately. The federal government’s swift decision-making may be understandable in light of the possibility that the matter could spread into a financial crisis, but the regulatory authorities cannot escape responsibility for having been negligent in supervision.

As a follow-up measure, it has been reported that authorities are reviewing plans to impose strong capital and liquidity regulations on banks with assets of $100 billion or more. Even in the United States, which is known for having the most advanced financial system, the repeated pattern continues in which new regulations are created by the government only after an incident occurs.

The lessons for us from bank failures originating in the United States are significant. During a period of rising interest rates, corporate funding difficulties are intensifying, and instability in financial markets continues amid a worsening real economy. Korea, too, must continue to implement appropriate macroprudential policies through ongoing monitoring of financial stability.

Unlike commercial banks, there is considerable concern centered on the secondary financial sector over the possibility of insolvency in real estate project financing loans and other lending tied to the downturn in real estate and construction. The role of regulatory authorities in supervision and oversight must be faithfully carried out by proactively and closely diagnosing the possibility of financial institution insolvency and reducing that risk. It is also important to uphold principles regarding whether public funds should be injected and where responsibility lies in cases of insolvency or bankruptcy, issues that always become contentious.

Yun Seol, Professor at Kyungpook National University

---

Original title: SVB의 파산이 주는 교훈

Author: Yun Seol

Date: 2023-04-06

Source: https://www.cfe.org/bbs/bbsDetail.php?cid=press&idx=25526