Sunday night, the U.S. government announced that all depositors in the failed Silicon Valley
Bank will have access to their money. In essence, Federal Deposit Insurance Corporation
protection – usually limited to $250,000 per account – became unlimited. Additionally, the
Federal Reserve created a new program to help protect other banks from depositor flight.
These were the right steps to avoid contagion, but they also reveal a fundamental problem in the
U.S. banking system.
Of itself, Silicon Valley Bank is a relatively minor player in the U.S. (and global) financial
system. With assets and liabilities of roughly $200 billion each before its collapse, SVB was a
medium-sized bank, one that also mostly catered to the world of venture capital and startups. It
was not a behemoth like the banks and investment banks that caused the global financial crisis of
2007-2008.
Ironically, SVB’s smaller size is also why it matters so much.
How so? Because following the global financial crisis, U.S. regulators distinguished between
smaller banks and “systemically important banks,” or SIBs, ones that alone could wreck the
financial system and economy if they were to fail. For depositors at SIBs, all their money is
effectively insured to prevent bank runs. That insured coverage, of course, comes with strings
attached, namely that SIBs are more closely scrutinized by regulators than other banks.
Depositors at smaller banks, such as SVB, on the other hand, are only formally insured up to
$250,000. Over that amount, as the FDIC announced on Friday when it shuttered SVB,
depositors are treated like ordinary creditors. The implication is that when a bank like SVB fails,
large depositors may only get pennies on the dollar back once other creditors are satisfied.
Unsurprisingly, therefore, large depositors across the U.S. got cold feet following SVB’s sudden
failure. If it could happen at SVB, it could happen anywhere. To no one’s surprise, therefore,
reports began circulating that runs were beginning at other banks that had not been designated
systemically important.
The irony is rich. Suddenly, non-SIBs are systemically important. And if the government had not
acted as it did in covering the potential losses of uninsured depositors, numerous regional players
would have experienced depositor flight and a series of bank failures would surely have
followed. This weekend was full of stories of companies worrying about how to make payroll
because money was suddenly frozen at SVB. Given the interlocking relationships of financial
institutions and their important links to the real economy, it is difficult to overstate the risks to
the U.S. financial system and economy that would have erupted.
Some have argued that SVB is a “one-off.” Post-mortems, which have already begun, have
tended to focus on a narrow and poorly diversified deposit base as well as an imprudent policy of
investing in bonds without appropriate risk management.
But to conclude that SVB is an isolated incident is to miss the broader point. Banks are
institutions that exist on confidence. No matter how well or poorly they are managed, when
confidence evaporates, all banks—the good ones and the bad ones—head to the abyss.
So, yes, SVB appears to have been poorly managed. But banks are not like other private-sector
businesses. Failures cannot be assumed to be purely idiosyncratic or isolated events. Failure
cannot be ring-fenced if it also sows doubt or increases risk. If a bank failure erodes depositor
confidence more broadly, then the good, the bad, and the ugly face the same risk of depositor
flight and failure, taking jobs, livelihoods, and—conceivably—the economy down with them.
So, what’s to be done?
In the short run, the Federal Reserve in its new Bank Term Funding program has made credit
available to banks suffering large-scale deposit withdrawals. But the lender of last resort function
is not meant to be a permanent replacement for private sector deposits. Moreover, for as long as
the Fed is managing a banking crisis, it will be distracted from its other primary goal, fighting
inflation.
The more durable solutions reside with other branches of government. Depositors could be
reassured if SVB can be sold to a bank sound enough to restore the faith of all depositors. The
Treasury, FDIC, and other regulators may be able help make that happen in the next day or so.
But in the long run, the risk of large deposit runs may require higher insured deposit amounts.
Deposit insurance rates would accordingly have to rise to adequately fund those contingent
liabilities. Raising deposit insurance levels would also mean that regulation of small and mid-
sized banks would have to be intensified, along the lines of what now exists for SIBs. Many
inside the world of finance would chafe at the expanded role of regulators in finance. Politically,
it could be challenging to achieve.
If we have learned anything from the SVB debacle, it is that bankers, left to themselves, can not
only bring down their own banks—they can also take the entire financial system with them.
It has been said that war is too important to be left to the generals. That adage seems to also
apply to finance. Banking may simply be too important to be left to the bankers.