Logo of the Federal Deposit Insurance Corp. building in Washington, DC.

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While the collapse of SVB might have been predictable, what was surprising was the US regulators’ response and the precedent it sets, write Itay Goldstein and Yao Zeng.

Silicon Valley Bank (SVB) suddenly collapsed just one week after making it to Forbes’ America’s Best Banks list, turning one of those best banks into the second-largest bank failure in US history. This immediately led to a storm in the global financial system. What was so striking is just how classic a bank run it was.

The 2008 failures of Bear Stearns or Lehman Brothers seemed at least to highlight new concepts such as sub-prime mortgages and private securitisation. And since the crisis of 2008 we have been constantly introduced to new risks in the non-banking sector. So who would have thought that an old-school bank run was on the cards?

But maybe we should not have been that surprised. Banking is, after all, a risky business, and it is substantially based on the beliefs of the uninsured that the bank is sound and that this is how others perceive it. In fact, despite the common view that the banking system is under control, evidence of the flightiness of uninsured deposits has emerged in recent years. 

SVB took a large amount of interest-rate risk and did not manage it properly. Holding long-term bonds, the value of its assets was bound to fall as the Fed raised the interest rate to combat inflation. SVB chose to leave its assets unhedged, resulting in a bigger risk than necessary. So uninsured depositors had a reason to be nervous.

Equally crucial is the fact that SVB’s liabilities carried particular risks. SVB would perhaps have been just fine if the depositors were households or mom-and-pop businesses who never paid attention. In fact, a stabilising force in the banking business is the concept that banks are opaque and people never ask questions

Unfortunately, SVB’s depositors were different. The bulk of SVB’s depositor base was composed of shrewd entrepreneurs and corporate officers, and they had parked large amounts in uninsured deposit accounts. They were also highly connected to one another. When someone smelled something bad about SVB, the rumour spread like wildfire. No one wanted to be left behind and SVB, unsurprisingly, collapsed.

Going forward, perhaps the most striking development in the SVB saga is the unprecedented efforts led by the US Federal Reserve, Treasury and Federal Deposit Insurance Corporation to bail out SVB’s uninsured depositors as well as provide guarantees for those in other vulnerable banks. It is true that policy-makers and regulators had some good reasons to step in. 

Despite being a mid-sized bank, SVB was systemically risky in a sense. There could have been potential contagion to other banks, non-bank institutions, and, particularly, the tech sector because many start-ups relied on their SVB deposit accounts to make payroll payments. The tech sector on the west coast is already in a long winter, as negative news on lay-offs continues to flow, with Meta recently announcing plans to lay off another 10,000 employees. After all, nobody wants a repeat of 2008.

These bailouts should not be taken lightly. One wonders whether the bailout effectively sentenced the $250,000 deposit insurance limit to death. Of course, it would be hard to argue that $250,000 was the magic number, and calculating the optimal design of deposit insurance is not easy. But the unconditional deposit bailout raises tremendous moral hazard concerns going forward. 

Yes, SVB equity was completely wiped out, and the CEO and board all lost their jobs. But the issue is not just about SVB equity. Banks may be encouraged to take more risks knowing that they are guaranteed at higher levels, in particular with the loans to other vulnerable banks that are now available.

Perhaps the trickiest dilemma faced by the Fed going forward is that between price stability and financial stability. Interest rates have long been perceived as the most powerful tool to combat inflation and achieve price stability. But we have been increasingly aware that raising rates too quickly might backfire and lead to financial instability well before any recession arrives. 

And it’s not limited to the banking system. The famous “taper tantrum”, driven by a simple speech by then Fed chair Ben Bernanke to reduce the Fed’s balance sheet in 2013, led to panic in bond mutual funds. The UK’s entire pension fund industry was shaken and almost plunged the country into a financial crisis in 2022. And today, private equity everywhere is perhaps subject to even larger hidden risks. The SVB fallout is a vivid reminder of how delicate these trade-offs are.

So, what have we learned? After many years of more strict bank regulation, the banking system is still prone to plain-vanilla risks. Bailouts can serve a short-term purpose but pose a long-term risk. And the trade-off between financial stability and price stability is very real. While solutions are not easy, perhaps a good amount of risk management could have gone a long way to avoiding some of this mess and making these lessons less pertinent.


Itay Goldstein is the Joel S. Ehrenkranz family professor and professor of finance, and Yao Zeng is an assistant professor of finance, both at the Wharton School of the University of Pennsylvania.


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