When discussing issues like “why does deposit insurance exist” and “why does the government regularly look over the financial accounts of banks,” people like me often end up describing bank runs. However, our examples tend to be old ones, often drawn from movies like “Mary Poppins,” “It’s a Wonderful Love,” or old westerns. Our “modern” example tend to be the Northern Rock bank run in the UK back in 2007 or the runs triggered by the failure of the Home Savings Bank of Ohio back in 1985.

But now, and for years to some, we have the example of the bank run that happened earlier this year at Silicon Valley bank. The Federal Reserve has just published its “Review of the Federal Reserve’s Supervision and Regulation of Silicon Valley Bank” (April 2023). The report is both useful and unsatisfying.

The unsatisfactory part is that the bank run at SVB happened on March 9. But as the report explicitly states: “The report does not review the events that occurred after March 8, 2023, including the closure of SVB on March 10, 2023, by the California Department of Financial Protection and Innovation (CDFPI), and the actions on March 12, 2023, by the U.S. Department of the Treasury, the Board of Governors of the Federal Reserve System (Board), and the Federal Deposit Insurance Corporation.”

Thus, those looking for a discussion of how the SVB situation affected other banks, or how it SVB contributed to the giant Credit Suisse bank being shut down and taken over by UBS in Switzerland, or how the run on SVB actually unfolded on March 9–well, you need to look somewhere else or wait for a follow-up report. For those interested in whether it was a useful policy step or an overreaction for the Fed to declare that all bank deposits would be protected, even those that far exceeded the $250,000 legal limit, you will need to look elsewhere.

In short, this report is about the lead-up to the SVB debacle, not what followed. But within that limit, there are many details of interest.

The report tells the basic story. SVB was a bank where more than half the deposits were from small new companies, mostly backed by venture capital, not from typical households with a bank account. These companies were holding large amounts at SVB, often measured in millions of dollars.

SVB took a substantial share of these funds and invested them in long-term debt, with a focus on US Treasury bonds or mortgage-backed securities also guaranteed by the federal government. With these kinds of investments, there is essentially zero risk of default. But there is a different risk: if you lock yourself into long-term debt that pays low interest rates, you are going to have a problem when interest rates go up. Say that you buy a 10-year bond with a face value of $100 that pays 1% interest. After interest rates go up, there are now 10-year bonds with a face value of $100 that pay 3% interest. When the bonds that pay a higher interest rate become available, no one is going to want to pay as much for the earlier bonds that have only a 1% interest rate. But SVB did not take steps to hedge against that risk of higher interest rates.

Usually, if a bunch of depositors want to take money out of a bank, the bank can sell some of the bonds it is holding, if needed, and give the depositors their money. But when the value of the bonds has declined, then if a bunch of depositors want to take money out of the bank, and the bank starts selling the low-interest bonds it is holding, the bank won’t have enough money to pay off the depositors. Remember these venture-capital backed firms were holding millions of dollars each at SVB, far above the amount protected by federal deposit insurance. The word went out that it might be safer to withdraw their fund, and it happened with rush. As the report notes:

Uninsured depositors interpreted SVBFG’s announcements on March 8 as a signal that [the firm] was in financial distress and began withdrawing deposits on March 9, when SVB experienced a total deposit outflow of over $40 billion. This run on deposits at SVB appears to have been fueled by social media and SVB’s concentrated network of venture capital investors and technology firms that withdrew their deposits in a coordinated manner with unprecedented speed. On the evening of March 9 and into the morning of March 10, SVB communicated to supervisors that the firm expected an additional over $100 billion in outflows during the day on March 10. SVB did not have enough cash or collateral to meet the extraordinary and rapid outflows. … This deposit outflow was remarkable in terms of scale and scope and represented roughly 85 percent of the bank’s deposit base. By comparison, estimates suggest that the failure of Wachovia in 2008 included about $10 billion in outflows over 8 days, while the failure of Washington Mutual in 2008 included $19 billion over 16 days.

Again, this is a report more about what happened than about policy steps. But part of what happened is that the bank management didn’t handle the risk of higher interest rates and the bank regulators didn’t intervene in time. The report hands out some blame on these issues, too.

For corporate management:

The full board of directors did not receive adequate information from management about risks at Silicon Valley Bank and did not hold management accountable for effectively managing the firm’s risks. The bank failed its own internal liquidity stress tests and did not have workable plans to access liquidity in times of stress. Silicon Valley Bank managed interest rate risks with a focus on short-run profits and protection from potential rate decreases, and removed interest rate hedges, rather than managing long-run risks and the risk of rising rates. In both cases, the bank changed its own risk-management assumptions to reduce how these risks were measured rather than fully addressing the underlying risks.

For the bank regulators, an issue was that large banks are held to tighter standards than small banks. But what about a very rapidly expanding bank? Although there was substantial concern expressed by the bank supervisors, there was also a sense that the bank should be allowed a little time to to adjust to the more strict standards of larger banks. This decision obviously doesn’t look good in retrospect.

While the firm was growing rapidly from $71 billion to over $211 billion in assets from 2019 to 2021, it was not subject to heightened supervisory or regulatory standards. The Federal Reserve did not appreciate the seriousness of critical deficiencies in the firm’s governance, liquidity, and interest rate risk management. … As Silicon Valley Bank continued to grow and faced heightened standards in 2021, the regulations provided for a long transition period for Silicon Valley Bank to meet those higher standards and supervisors did not want to appear to pull forward large bank standards to smaller banks in light of policymaker directives. This transition meant that the new supervisory team needed considerable time to make its initial assessments. After these initial assessments, liquidity ratings remained satisfactory despite fundamental weaknesses in risk management and mounting evidence of a deteriorating position. The combination of internal liquidity stress testing shortfalls, persistent and increasingly significant deposit outflows, and material balance sheet restructuring plans likely warranted a stronger supervisory message in 2022. With regard to interest rate risk management, supervisors identified interest rate risk deficiencies in the 2020, 2021, and 2022 Capital, Asset Quality, Management, Earnings, Liquidity, and Sensitivity to Market Risk (CAMELS) exams but did not issue supervisory findings. The supervisory team issued a supervisory finding in November 2022 and planned to downgrade the firm’s rating related
to interest rate risk, but the firm failed before that downgrade was finalized.

In the broader legislative context, the Economic Growth, Regulatory Relief, and
Consumer Protection Act (EGRRCPA) of 2019 was based on the idea that the giant “global systemically important banks” needed closer regulation, but other banks were fine with lower levels of regulation.

Over the same period that Silicon Valley Bank was growing rapidly in size and complexity, the Federal Reserve shifted its regulatory and supervisory policies due to a combination of external statutory changes and internal policy choices. In 2019, following the passage of EGRRCPA, the Federal Reserve revised its framework for supervision and regulation, maintaining the enhanced prudential standards (EPS) applicable to the eight global systemically important banks, known as G-SIBs, but tailoring requirements for other large banks. For Silicon Valley Bank, this resulted in lower supervisory and regulatory requirements, including lower capital and liquidity requirements. While higher supervisory and regulatory requirements may not have prevented the firm’s failure, they would likely have bolstered the resilience of Silicon Valley Bank.

I would only add that players in financial markets, including banks, investors, and regulators, have a tendency to relax about risks that haven’t occurred for awhile. By early 2022, interest rates has been rock-bottom low since late in 2008–for more than a decade. Some economic reports suggested that low interest rates would persist long into the future. Those who paid to hedge against the risks of higher interest rates had been doing so, without any apparent need, for more than a decade. At some point, the risks posed by higher interest rates just weren’t taken as seriously as they should have been: not by banks, not by investors, and not by the Fed.

But as IMF Managing Director Kristalina Georgieva said a few weeks ago: “There is simply no way that interest rates would go up so much after being low for so long and there would be no vulnerabilities. Something is going to go boom.” My guess is that we have not yet seen the last of things that go boom.