Originally published at Project-Syndicate | March 16th, 2023
In 2018, US lawmakers loosened banking regulations on the spurious grounds that smaller banks do not pose systemic risks to the stability of the financial system. Unfortunately, everyone will have to relearn the hard-won lessons of past banking crises.
WASHINGTON, DC – The collapse of Silicon Valley Bank in northern California and Signature Bank in New York are the largest bank busts since 2008. Regional and mid-sized bank stocks have tanked, and depositors and businesses are worried about who might be next. US President Joe Biden’s administration and the Federal Reserve have duly stepped in to prevent more panic-driven bank runs, and to shore up the broader financial system where needed.
For legislators, regulators, bank boards, and CEOs everywhere, these sudden bank failures are a stark reminder that the work of ensuring a firm’s stability and soundness never ceases. In the case of SVB and Signature Bank, there is plenty of blame to go around.
But a good deal of it lies with those members of Congress and former President Donald Trump’s administration who listened to bank lobbyists and decided that it would be wise to lighten the regulatory and capital burden on so-called smaller banks. Under legislative changes in 2018, banks with assets of less than $250 billion were exempted from the stricter supervision (including capital and stress testing) to which large banks are subjected. The grounds for doing so – that such banks do not pose systemic risks to the stability of the US financial system – were clearly spurious.
Shockingly, Barney Frank, one of the architects of the post-2008 Dodd-Frank banking legislation, actually supported this regulatory exemption, having since become a member of Signature Bank’s board. Obviously, bank board members should not undermine the stability of their own firms; but that appears to be what happened here. If lawmakers had listened to the late Paul Volcker, who warned against eliminating the Volcker Rule (a prohibition against using deposits for proprietary trading) for smaller institutions, SVB and Signature Bank might have been spared.
We can now see that, as in the 2007-08 financial crisis, panic can spread quickly from a small bank to larger ones, and then across borders and markets. Given this dynamic, it is essential that Congress revisit the ill-considered regulatory unraveling of Dodd-Frank. But the problem doesn’t stop there. Aside from the loosening of financial rules, regulators and supervisors also dropped the ball.
Where were the Federal Reserve Board supervisors in San Francisco and Washington as these large regional banks loaded up on risky and highly volatile tech, crypto, and other assets? Why were supervisors and regulators not paying more attention to their micro-prudential responsibilities and the entirely predictable spillover effects that monetary-policy tightening could have on banks’ financial stability? Where were California’s bank regulators? Were they too cozy with SVB to be sufficiently critical?
The American public has a right to answers to these questions. They are now paying the price for private risk-taking and greed, by guaranteeing 100% of uninsured deposits belonging mostly to venture capitalists, crypto investors, and others who should be sophisticated enough to bear the downside risks of their actions.
What about the firms themselves? Since a bank’s managers are responsible for its success or failure, they should be held to account, including by facing legal jeopardy when appropriate. The public has a right to know what questions – if any – the SVB and Signature Bank boards were asking as risks jumped, rates rose, concentration risks loomed, and costs increased. Just hours before SVB’s collapse, its CEO, Greg Becker, reportedly paid bonuses to employees. Why would SVB’s board agree to this?
It should come as no surprise to learn that Becker, too, advocated a loosening of the Dodd-Frank regulations. After he got what he wanted, SVB took its customers’ deposits and went in search of higher yields.
While other banks avoided the growing risks associated with volatile cryptocurrencies and excessive concentration on risky tech startups, SVB and Signature Bank leaned in. While risk managers elsewhere adjusted their portfolios in anticipation of the monetary tightening the Fed had clearly signaled, these banks failed to recalibrate (and SVB didn’t even have a senior risk manager in place during the key months before its collapse). While other banks’ managers understood that the Fed was taking away the proverbial punch bowl of easy money, SVB and Signature kept dancing.
In the end, both made the mistake of adopting their clients’ mindsets. Their internal cultures and norms seem to have mutated to mirror those of Silicon Valley: They moved fast, lent fast, broke things, and ultimately destroyed themselves.
Too many people in Congress, federal regulatory agencies, and bank C-suites lack the visceral recollection of good times gone bad. Too many legislators and policymakers (particularly in the Trump White House) believed the arguments of bank lobbyists who were desperate to open new avenues for risk taking. In the end, regulators and supervisors were caught out as the Fed rapidly raised interest rates to restrain inflation – a shift that was always going to have implications for bank risks and portfolios.
One hopes that this crisis will be relatively limited following the swift interventions by the White House, the Treasury, the FDIC, and the Fed. But Credit Suisse’s woes indicate that the past week’s events may already be having global repercussions. Even if the US economy escapes another financial calamity, we must revisit and relearn the lessons of past banking crises. That means making certain that those who are responsible for these bank collapses face hard questions and a real reckoning.
William R. Rhodes: A former chairman and CEO of Citibank, is President of William R. Rhodes Global Advisors, LLC and author of Banker to the World: Leadership Lessons From The Front Lines Of Global Finance (McGraw Hill, 2010).
Stuart P.M. Mackintosh: Executive Director of the Group of Thirty.