SVB: The Blame Game Begins
There is always more than one reason for a bank failing. It starts with poor management. Matters get worse if the bank’s directors and regulators fail to heed warning signs of deteriorating conditions. Silicon Valley Bank (SVB) appears to be such a case. In walking through this failure, I am relying on public data, and, therefore, I acknowledge I may not have all the facts.
First, it goes without saying that the principle fault lies with management and the board. There is no need to explain this further.
Second, the Federal Reserve (Fed) and its monetary policy contributed to the problem. Its policies of printing enormous amounts of money and holding interest rates close to zero for over a decade created the expectation that such a policy would last forever. The Fed said it would keep interest rates low for a “considerable period.” Bank management believed this promise and expanded its use of highly concentrated uninsured deposits. It then invested a good part of this money in billions of dollars of long-term government-guaranteed securities, assuming their value would remain steady in a environment of perpetually low interest rates. Management foolishly failed to allow for a reversal of that policy even as the reversal was taking place.
Third, bank supervisors failed to heed the red flags showing that the bank was funding its growth with high concentrations of uninsured deposits. The bank grew by over 60% per year for three years. Such growth should have been examined and dealt with early on in the bank’s expansion. If this had been done, its regulator would have observed the concentration of deposits and could have taken action to require a more stable funding source, which would have also slowed its growth.
Fourth, the regulator apparently relied on the bank’s risk-weighted capital standard for judging SVB’s balance sheet strength. Under the risk-weighted system government and government-guaranteed securities are not counted as part of the balance sheet for calculating the ratio of capital to risk-weighted assets. This allowed the bank to report a ratio of around 16%, giving the appearance of strongly capitalized bank. However, this calculation failed to account for interest rate risk in its securities portfolio or the risk of having a highly concentrated balance sheet. It misled the public, and apparently the regulators.
By contrast, if the regulator had focused on SVB’s ratio of equity capital to total assets, including government securities, the regulator would have observed a ratio near 8%; and if the regulator had calculated the ratio as tangible capital to assets (removing intangibles and certain unbooked losses from capital) the ratio would have fallen to near 5%. What this would have disclosed to the world is that the bank’s assets could not lose 16% of of their value before insolvency, but only 5%, a stark contrast.
Had the regulator not relied on the misleading risk-weighted capital measure, it might have take actions sooner. A simple capital-to-asset ratio tells the regulator and public in simple, realistic terms how much a money a bank can lose before becoming insolvent. The regulatory authorities need to stop pretending that their complex and confusing capital models work; they don’t.
Also, regulators know that rapidly growing banks are inherently more risky and require more capital to absorb the lending and investing mistakes that come with exceptionally fast growth. In this instance the regulator should have insisted that such growth be funded with substantially more capital to allow for the risk.
Whether SVB would have failed if these errors had been addressed earlier and vigorously, we cannot say for certain. However, failing to address them assured its failure.
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