CLOSING ENTRY: More to come

The Federal Reserve released its banking report April 28 with much anticipated details on the collapse of Silicon Valley Bank. While the Fed owned up to the second biggest bank failure in history, saying that it “did not fully appreciate the extent of the vulnerabilities as Silicon Valley Bank grew in size and complexity” and “did not take sufficient steps” to ensure that SVB address its problems quickly, it also pointed out improper management rife throughout the bank.

Michael Barr, vice chair for supervision, pulled no punches with the opening line, “Silicon Valley Bank (SVB) failed because of a textbook case of mismanagement by the bank. Its senior leadership failed to manage basic interest rate and liquidity risk.” He did go on to say the overall banking system is in strong condition and that SVB was an “outlier.” The report cites social media as a culprit in the risks of a bank run, such as this case where a concentrated depositor base was able to quickly spread concerns and use modern technology to immediately withdraw their funds.

SVB’s faults were exacerbated by its extreme growth, having tripled in size between 2019 and 2021. Benefiting from a cash rich economy spurred by pandemic-related stimulus and rock bottom interest rates, a thriving tech sector and deregulation, SVB’s assets jumped from $71 billion in 2019 to $211 billion in 2021. Following the Great Recession, the Dodd-Frank Act of 2010 created stricter regulations for banks with over $50 billion in assets and made annual “stress tests” mandatory. However, in 2018, this standard was increased to only apply to banks with assets over $250 billion. SVB fell just below this minimum and was exempt from testing since 2018.

At the time of its failure, SVB had 31 unaddressed “safe and soundness supervisory warnings” — triple the average number of peer banks, according to the Fed. SVB fell prey to a concentrated business model that catered to the tech and venture capital industries. It also used lax risk management practices and relied heavily on uninsured deposits. The bank’s management received satisfactory rankings from 2017 to 2021 despite repeated observations of risk management weaknesses. The report notes that SVB changed its risk management assumptions to make its long run risks and exposure to rising interest rates acceptable.

As of early May, banking troubles persist. On May 1, First Republic Bank was seized by regulators and mostly sold off to JPMorgan Chase & Co. Shareholders and debtholders of First Republic were wiped out when the bank went into government receivership. The Federal Deposit Insurance Corp. will pay out $13 billion to cover First Republic losses and provide $50 billion of financing to JPMorgan, and JPMorgan will pay $10.6 billion to the FDIC.

Since the rapid pickup of inflation beginning in 2021, the Fed unleashed interest rate hikes throughout 2022 and into this year, effectively asking the economy to slow down. Now, many banks left holding devalued assets and passing on higher borrowing costs are carrying out the marching orders of a slowed economy. This brought the weaknesses of SVB, Signature Bank, and First Republic to the surface.

So, what can we expect next? There have been calls to raise the FDIC insurable limit of $250,000 – the amount covered per depositor, per insured bank, for each ownership category – and debates over making coverage unlimited. While this coverage amount may increase, as is fair to be expected since most financial metrics are reevaluated or indexed with natural inflation, an unreasonable limit or no limit at all should not be considered. This total shift of risk to the government is bound to promote moral hazard and would allow poorly managed banks to lure depositors with favorable savings rates or loans who know the FDIC would be ready for a bailout.

The Fed’s report suggests implementing a range of rules for banks with over $100 billion of assets, seemingly going backwards closer to the original Dodd-Frank regulation. The report also proposes better accounting for unrealized gains or losses on available-for-sale securities to allow a clearer picture in the event of a financial event. It is unlikely regulators could tell a bank who their customers can be to deconcentrate a depositor base. SVB, Signature Bank, and First Republic were all very exposed to the startup and venture capital industry, but this risk should be front and center for bank management.

Lastly, communication can occur at breakneck speed in our modern economy, thanks to technology. Many pundits might be surprised to see the Fed’s report mention social media in an autopsy of SVB, but it is warranted. It may appear too soon to even mention AI and its relevance to bank runs, but how can one not? Expect more discussion around limiting or slowing down the availability of withdrawals, particularly on large uninsured deposits. At least in “It’s a Wonderful Life,” George Bailey had time, as customers had to literally run to his bank and get in line to ask for their money back. In 2023, all it takes is a click of a button.

Bryan M. Kuderna is a Certified Financial Planner and the founder of Kuderna Financial Team, a New Jersey-based financial services firm. He is the host of The Kuderna Podcast. His new book, “WHAT SHOULD I DO WITH MY MONEY?: Economic Insights to Build Wealth Amid Chaos” is available wherever books are sold.