22 March 2023

CEPR's Dewatripont, Praet, Sapir: The Silicon Valley Bank collapse: Prudential regulation lessons for Europe and the world

This column draws two main lessons in this respect. The first is that the episode should increase the resolve of public authorities to further improve the resolution framework in the EU. The second is that the extent of protection, in both Europe and worldwide, of short-term deposits that (large and small) companies rely upon for their ordinary business is flawed and needs to be adapted.

While the collapse of Silicon Valley Bank appears to be an example of failure of both bank management and supervision, it also offers insights about prudential regulation. 

Silicon Valley Bank (SVB) was a bank with $212 billion in assets and $175 billion in deposits that was admittedly ‘special’: very specialised in tech, with mostly uninsured start-up deposits rather than retail deposits. It did not aggressively search for deposits by offering particularly high interest rates, so it did not ‘gamble for resurrection’. Instead, its problem stemmed from its asset side, which did not primarily consist of loans but was instead mostly standard and liquid securities that were poorly hedged as far as interest rate risk was concerned. The recent increase in interest rates combined with poor hedging lowered the value of its assets, and eventually led to insolvency when some depositors sought to withdraw their deposits. 

SVB clearly looks like an example of US failure in both regulation and supervision. Together with other banks, SVB had successfully lobbied Congress for weaker regulation, which allowed it (and others) to rely on held-to-maturity accounting, and to be exempted from the Basel liquidity coverage ratio (LCR) requirement.

In terms of crisis management, after unclear communication by the authorities (“FDIC will not do a bailout but will try and help uninsured depositors, through a dividend”), the weekend of 11/12 March 2023 ended with the decision to fully guarantee uninsured deposits too, so there was a bailout (which the authorities may or may not recoup in the future through fees levied on the banking sector as a whole). This decision echoes the earlier ones for hedge fund LTCM or investment banks Bear Stearns and Merrill Lynch (and differs from the Lehman decision), with a rationale that is both similar to (avoiding runs) and different from (the goal this time is to protect tech startups rather than financial creditors) these three previous cases...

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