(Bloomberg) — The head of the Federal Deposit Insurance Corp. warned a gathering of bankers in Washington on Monday about a $620 billion risk to the US financial system.
Read the most from Bloomberg
By Friday, two banks had succumbed to it.
US regulators saw the threats growing enough and took enough action before the collapse of Silvergate Capital Corp this week and now the much larger SVB Financial Group is ready for a national debate.
SVB’s sudden death – the biggest in more than a decade – has left Silicon Valley’s legion of entrepreneurs bewildered and angry. In Washington, politicians are taking sides, with Biden administration officials expressing “full confidence” in regulators, even as some watchdogs are rushing to review blueprints for handling past crises.
To his credit, FDIC Chairman Martin Gruenberg’s speech this week wasn’t the first time he expressed concern that banks’ balance sheets were loaded with low-interest bonds that could hold hundreds of billions amid the Federal Reserve’s rapid rate hikes. Dollars were lost in value. This increases the risk that a bank could fail if withdrawals force it to sell those assets and realize a loss.
But despite their concern, the collapse of the two California lenders in the middle of the same workweek marked a stark contrast with the years following the 2008 financial crisis, when regulators including the FDIC seized hundreds of failing banks with ease. , usually rolled up to his headquarters. After the close of US trading on Friday.
Even in the worst moments of that era, executives at Bear Stearns Cos and Lehman Brothers Holdings Inc. managed to intervene while the markets were closed for the weekend.
In this case, crypto-friendly Silvergate limped into a second workweek after the watchdog warned on March 1 that mounting losses could undermine its viability. The bank finally said on Wednesday that it would be closing.
The same day, SVB indicated it needed to strengthen its balance sheet, fueling fears of a wider crisis. A deposit run and bank seizure ensued. The KBW Bank index of 24 large lenders suffered its worst week in three years, falling 16%.
“There was a bit of a regulatory blind spot with Silvergate,” said Keith Norica, who served as acting comptroller of the currency in 2017. This happens to others with similar funding mismatches.
Representatives for the FDIC and the Fed declined to comment.
The drama is already fueling debate in Washington over the Dodd-Frank regulatory overhaul enacted after the 2008 crisis, as well as its partial rollback under President Donald Trump.
Trump eased oversight of small and regional lenders when he signed a far-reaching measure designed to lower the cost of complying with regulations. A measure in May 2018 raised the threshold for being considered systemically important – a label imposing requirements including annual stress testing – from $250 billion in assets to $50 billion.
SVB had deposited only $50 billion at that time. By early 2022, it grew to $220 billion, eventually ranking as the 16th largest US bank.
The lender achieved that meteoric rise by scooping up deposits from red-hot tech startups during the pandemic and putting money into debt securities as the last stretch of rock-bottom rates.
As those ventures subsequently burned through funding and liquidated their accounts, SVB posted an after-tax loss of $1.8 billion for the first quarter, triggering panic.
‘Real Stress Test’
“This is a real stress test for Dodd-Frank,” said former Fed governor Betsy Duke, who later chaired the board of Wells Fargo & Company. “How will the FDIC resolve the bank under the Dodd-Frank requirements? Investors and depositors will be watching everything carefully and assessing their risk of losing access to their funds.
One thing that might help: SVB was required to have a “living will,” presenting a map to regulators to wind down operations.
“The confidential resolution plan is going to describe the potential buyers for the bank, the franchise components, the parts of the bank that are important to continue,” said Alexandra Barrage, a former senior FDIC official at the law firm Davis Wright Tremaine. “Hopefully the resolution plan will assist the FDIC.”
He said the issues that arose were “a perfect storm” at both Silvergate and SVB, including an unusual concentration of deposits from certain types of customers. This could limit how many other firms face trouble.
One complication is that the Fed has less room to help banks with liquidity, as it is in the midst of trying to get cash out of the financial system to fight inflation.
Another is that a generation of bankers and regulators was not in charge during the previous period of interest rate hikes, raising the possibility that they will not forecast growth as readily as their predecessors.
In fact, even a bank failure for a time has been rare. SVB was the first since 2020.
“We are seeing the effects of decades of cheap money. Now we have rapidly rising rates,” Norica said. “Banks haven’t had to worry about it for a long time.”
— With assistance from Jenny Surane.
Read the most from Bloomberg Businessweek
©2023 Bloomberg L.P.