The panel, moderated by Luxembourger Jean-Pierre Zigrand, associate professor of finance at the London School of Economics (LSE), featured lively conversation around supervision linked to recent banking tumult, namely the collapse of Silicon Valley Bank on 10 March and the takeover of Credit Suisse by UBS on 19 March.
“The press has been full, almost ad nauseam, with discussions about the implications of these banking difficulties,” began Charles Goodhart, emeritus professor in the financial markets group at the LSE during Thursday’s webinar, mentioning commonly cited topics in these discussions--interest rates, monetary policy and inflation. “I want to turn to a completely different aspect of these problems, which is the regulatory structure that we have and the problems that it now faces.”
Bail-in process not followed
“We thought we had an agreed process for dealing with failing banks, which was known as a bail-in process,” continued Goodhart. The bail-in process aims to recapitalise a bank and restore compliance with the capital requirements, according to Switzerland’s financial regulator Finma. “Now we’ve had two countries with two problems--the US, with the Fed, with SVB, Signature and Silvergate--and now Switzerland with Credit Suisse.”
In neither case was the bail-in process followed, noted Goodhart. Instead, the failure of the SVB--the 16th largest bank in the US--was described as “systemic” and “rather than follow the bail-in process, effectively, the Fed undertook a bailout process.” In the Credit Suisse situation, “the order in which bank creditors should lose their money in the case of insolvency was turned upside down--whereby the cocos [contingent convertible bonds], AT1, were completely wiped out, and the equity holders were not.”
This indicates that whenever there’s a problem, central banks will not abide by the bail-in process, Goodhart argued. “The situation in the US is now that almost any bank is going to be subject to this systemic exception,” he said. “So we’re going to have to completely reconsider the structure of regulation.”
“As much a run on the regulator”
LSE visiting professor Lutfey Siddiqi prefaced his response with a caveat. “I think we’re in the thick of it. Things are playing out, too early for answers. But I think we need to ask some pretty robust questions.”
Expectations have been “severely” conditioned by a decade of quantitative easing and a “flood” of funding following the start of the covid pandemic. “One of the unfortunate hallmarks of that period has been a neglect, a spurning and a demotion of the depositor in the financial system,” he added. Restoring depositors as the “key constituents of the system, that might just prove to be the key to averting systemic risk.”
Moreover, Siddiqi thinks that “the regulator has a lot to answer for. I think it’s not just the regulation, we’ve got to ask whether they’re part of the same echo chamber as the regulated.” Unlike SVB, Credit Suisse was one of the 30 globally systemic important banks, he noted. According to its annual report and risk report, it was compliant and doing well enough for the Swiss National Bank to offer CHF50bn in liquidity a few days before its takeover, said Siddiqi. How could a bank like this “vaporise in this manner?” he asked. “We need to ask these uncomfortable questions without necessarily prejudging the answers.”
“I think this was as much a run on the regulator as it was a run on the bank,” he added. “As we do a post-mortem, we need to think of regulators as being part of the system, not apart from it.” He offered plane crashes in the US as an example that could be borrowed from. After a plane crash occurs, the agency that investigates the incident--the National Transportation Safety Board--is not part of the department of transportation, meaning there’s a separation between the investigator and the regulator.
“Failure of supervision practice”
“We shouldn’t jump to conclusions too fast here. We need to dig more, and the Fed has promised to do so,” cautioned Ron Anderson, professor of finance at the LSE. “What I think we can say at this stage is that there was a failure of supervision practice in this case. It’s widely documented that the Fed had already noted risk control problems in SVB as early as 2019.” Blackrock did a risk analysis of SVB and found that they were “behind” or “very far behind” peer banks in almost every category.
“Consultants are often ignored by management when they don’t like the message,” admitted Anderson. “But how could the supervisors be ignored? And here, I don’t think there are any good excuses. And you have to wonder about it.”
Anderson posed several questions: Were supervisors too lax? Did supervisors think these were serious problems, but senior managers did not listen? Was there a view that the regional federal reserve can take care of regional banks? SVB CEO Greg Becker sat on the board of directors of the San Francisco Fed--did that allow him to deflect criticisms?
Maybe it’s time to look back at old lessons and relearn them, suggested Anderson, referring to the savings and loan crisis in the 1980s and how to spot duration risk. “It seems that with all the bells and whistles of the new regulatory regime, people rely more heavily on the tools that were produced after the financial crisis, and seem to forget some of the basic ABCs of the profession. So I think that a little bit of better qualification of the supervisors might have done something to avoid some of these problems.”
Need for “massive” regulatory reconsideration
“The mindset that we acquired over this decade of quantitative easing, for want of a better word, a VC [venture capital] mindset, that we brought into everything--a narrative bubble, revenues don’t matter, process can be sloppy, it’s okay--whether that has infected various other parts of the system or not, I think is a question to ask,” said Siddiqi. “I would have thought, some bankruptcies, some banks going under is par for the course in this part of the cycle. What I’m absolutely shocked about is the apparent lack of preparedness on the prudential side of things.”
“The regulators will have more to do, because what SVB was problematical for was, as interest rates rose, the valuation of longer duration assets, both public and private, went down very sharply. And the degree to which these duration risks, the interest rate risks were hedged, is something that we don’t generally know very clearly,” said Goodhart.
For him, the panel conversation highlighted the need for regulatory reconsideration. The situation should have never been allowed to develop--there were supervisory failures. “And that means that I think that there will have to be massive reconsideration, including what you do about the risk inherent in holding long-dated government bonds,” said Goodhart.
Panellists included Ron Anderson, Jon Danielsson, Charles Goodhart, Lutfey Siddiqi and Kathleen Tyson. The panel was moderated by Jean-Pierre Zigrand. Watch the video recording of the event here.