{"id":9432,"date":"2023-04-03T16:05:57","date_gmt":"2023-04-03T16:05:57","guid":{"rendered":"https:\/\/zacksim.com\/financial-professionals-insights\/?p=9432"},"modified":"2023-04-03T16:05:57","modified_gmt":"2023-04-03T16:05:57","slug":"the-root-cause-of-svb-bank-failure","status":"publish","type":"post","link":"https:\/\/zacksim.com\/financial-professionals-insights\/the-root-cause-of-svb-bank-failure\/","title":{"rendered":"The Root Cause of SVB Bank Failure"},"content":{"rendered":"\n

The 2008 Global Financial crisis was characterized by complex securities, too much leverage on bank balance sheets, and in many cases, excess risk-taking. There is also a strong argument that a well-meaning accounting rule, FAS 157, created unintended consequences in the banking sector as it forced many banks to take massive write-downs on hard-to-value assets (mortgage-backed securities, collateralized debt obligations, etc.), which crippled capital ratios and froze credit markets overnight. Many banks went from well-capitalized one day to insolvent the next, while also holding sizable portfolios of mortgage-backed securities that no buyer wanted.1<\/sup><\/p>\n\n\n\n

The current banking crisis \u2013 if we can call it a crisis \u2013 looks nothing like what I\u2019ve just described above.<\/p>\n\n\n\n

Instead of balance sheets riddled with subprime mortgages, derivatives, and near-worthless MBS portfolios (when marked-to-market), Silicon Valley Bank\u2019s (SVB) problems were rooted in taking in too many uninsured deposits and investing them in arguably the most boring, safe securities available: U.S. Treasuries and federally-backed<\/em> mortgage securities.2<\/sup><\/p>\n\n\n\n

The risk of default on U.S. Treasuries and federally-backed mortgage securities is essentially 0%, which hardly qualifies SVB as taking on too much risk. But the bank did appear to fail in another aspect of basic risk management: accounting for interest rate risk. As interest rates rise, the fair market value of fixed-rate securities falls, which means a bank may be forced to accept losses on these assets if they need to sell them to cover liabilities (deposits). That is, of course, what happened to SVB.<\/p>\n\n\n\n

Mismanaging interest rate risk is not new ground for banking problems in the U.S., historically speaking. The savings and loan crisis of the 1980s was driven by a mismatch between long-term loans and short-term deposits, which crushed banks when interest rates rose sharply in the late 1970s in the Fed\u2019s effort to fight inflation (sound familiar?).<\/p>\n\n\n\n

In SVB\u2019s case, supervisors at the Federal Reserve Bank of San Francisco had issued the bank six citations in the previous year, warning the bank that it was vulnerable to trouble and had \u201cmatters requiring immediate attention.\u201d By July of last year, the SF Fed had put SVB in full supervisory review and rated the bank as deficient in governance and controls. In the fall, regulators met with the bank to discuss their exposure to losses as interest rates rose. SVB did essentially nothing in response.3<\/sup><\/p>\n\n\n\n

Perhaps the lesson to garner from SVB\u2019s failure is that warnings and citations from regulators only matter if banks take steps to resolve issues, and\/or if regulators take bold action like forcing the bank to turn away deposits or to raise capital, or both. SVB also had the glaring problem of 94% uninsured deposits from an undiversified set of customers, which made it extremely vulnerable to a bank run.<\/p>\n\n\n\n

Fed supervisors in San Francisco may have held back from taking stronger action on SVB last year because of a mindset among Fed supervisors that uninsured deposits \u2013 versus brokered deposits or wholesale short-term funding \u2013 were a relatively stable and secure form of funding. That may very well still be the case, but as SVB showed, having those deposits concentrated in specific sectors (technology, life sciences) and with niche clientele (venture-capital funded companies) means the word can spread quickly that deposits are fleeing \u2013 which can trigger the psychological effect of a bank run.<\/p>\n\n\n\n

Bottom Line for Investors<\/strong><\/p>\n\n\n\n

As I\u2019ve written before, SVB was largely in a league of its own when it came to the level of uninsured deposits and unrealized losses on fixed-rate securities. The warnings the bank received from regulators in the year before its failure \u2013 and the lack of action taken in response \u2013 also pegs this as a crisis of mismanagement, in my view, not a symptom of systemic risk lurking elsewhere in the banking sector.<\/p>\n\n\n\n

I think the biggest risk now is in how banks and legislators respond from here. I\u2019ll be watching loan activity closely in the coming weeks and months, to gauge whether banks are \u2018playing it safe\u2019 and preferring to hold dollars versus lending them out. I\u2019ll also be tracking proposals for new regulations or other legislative action that may be taken in response to SVB\u2019s failure, the uncertainty of which may weigh on markets. The Fed, for instance, is now weighing higher capital and liquidity ratios for banks with over $100 billion in assets, lower than the current $250 billion threshold.<\/p>\n","protected":false},"excerpt":{"rendered":"

While it is understandable to compare the current bank problems to 2008, today’s issues do not appear to indicate systemic risk lurking in the banking sector.<\/p>\n","protected":false},"author":4,"featured_media":0,"comment_status":"closed","ping_status":"closed","sticky":false,"template":"","format":"standard","meta":{"footnotes":""},"categories":[181,1],"tags":[],"class_list":["post-9432","post","type-post","status-publish","format-standard","hentry","category-financial-professionals","category-mitch-on-the-markets"],"acf":[],"_links":{"self":[{"href":"https:\/\/zacksim.com\/financial-professionals-insights\/wp-json\/wp\/v2\/posts\/9432","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/zacksim.com\/financial-professionals-insights\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/zacksim.com\/financial-professionals-insights\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/zacksim.com\/financial-professionals-insights\/wp-json\/wp\/v2\/users\/4"}],"replies":[{"embeddable":true,"href":"https:\/\/zacksim.com\/financial-professionals-insights\/wp-json\/wp\/v2\/comments?post=9432"}],"version-history":[{"count":2,"href":"https:\/\/zacksim.com\/financial-professionals-insights\/wp-json\/wp\/v2\/posts\/9432\/revisions"}],"predecessor-version":[{"id":9434,"href":"https:\/\/zacksim.com\/financial-professionals-insights\/wp-json\/wp\/v2\/posts\/9432\/revisions\/9434"}],"wp:attachment":[{"href":"https:\/\/zacksim.com\/financial-professionals-insights\/wp-json\/wp\/v2\/media?parent=9432"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/zacksim.com\/financial-professionals-insights\/wp-json\/wp\/v2\/categories?post=9432"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/zacksim.com\/financial-professionals-insights\/wp-json\/wp\/v2\/tags?post=9432"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}