There are three key elements that led to the collapse of Silicon Valley Bank: risk on the asset side, liabilities, and looser regulation implemented in 2018, said Diane Pierret, who is assistant professor of finance at the University of Luxembourg and conducts research on subjects such as banking, monetary policy, regulation and risk.
Unhedged interest risk
“When it comes to the assets, Silicon Valley Bank had assets that were very sensitive to interest risk,” explained Pierret. “These assets, they lose value when interest goes up, which is exactly what happened with the Federal Reserve’s monetary policy.”
“You have on one side of the balance sheet--the asset side--interest risk, which was unhedged,” Pierret noted. “The first thing you teach to students who are going to work in a bank is how to hedge interest risks. There are different tools, different instruments, that are available to do that. And apparently, that was not done. So that’s probably a failure of the risk management team there.”
Indeed, SVB’s chief risk officer, Laura Izuriet, stopped serving as risk officer at the end of April 2022 and left the company in October 2022, according to SVB’s 2023 proxy statement. Kim Olson was appointed chief risk officer in January 2023.
Large amount of uninsured deposits, concentrated in one industry and one region
Banks mostly fund themselves with deposits, but “typically we have a lot of small retail deposits in the bank. And most of these retail deposits, because they are small amounts, they’re insured by the government--by the FDIC [Federal Deposit Insurance Corporation] in the US,” Pierret said. The standard insurance amount is $250,000 per depositor, per ensured bank, as explained on the FDIC’s website.
In the case of Silicon Valley Bank, however, “the business model was to attract very large deposits from the tech industry,” and, in particular, tech startups with a lot of cash from venture capital funding, for instance. “They had some cash to park, and they parked it in this bank that was paying higher interest rates on deposits. So that was a way to attract a lot of these large deposits, and all concentrated in one industry, one region,” explained Pierret.
This concentration would pose an issue. “It’s pretty clear that this was already a bomb, in that that any asset liability management department would have seen that this was not a sustainable model,” said Pierret. “But what’s really special here is this very large, uninsured deposit base, all concentrated in one industry, one region--Silicon Valley.”
Keeping in mind that the deposit insurance limit is $250,000 in the US, all these deposits were therefore not insured. Pierret added, “You’re really exposed to what we call concentration risk in your deposit base,” and “you completely forget about diversification benefits.”
Diversification of depositaries is not something that is covered by regulation, she said. “There are limits introduced by the Basel Committee for single counterparty exposure,” she explained. “But that being said, if you have all your counterparties that look the same, it’s like being exposed to one counterparty.” And if all these counterparties are so similar, they will also have liquidity needs at the same time, which is what happened here.
Reduced regulation in the US
At the end of 2022, Silicon Valley Bank had around $200bn in assets. “It’s regulated by the Fed, but it’s not regulated like the largest banks in the US,” noted Pierret, such as Citigroup or Bank of America. After the 2008 financial crisis, new regulations were implemented. But under the Trump administration, there was “a deregulation wave that was also pushed very much by lobbying banks, including Silicon Valley, to reduce the regulation burden for smaller banks.”
To be subject to the Federal Reserve’s regulatory stress tests, which tests how a bank would react to an increase in interest rates, for instance, the threshold was set at $250bn in assets. As its assets fell below the $250bn threshold, Silicon Valley Bank was therefore not on the radar for this kind of stress test.
But there wasn’t only an issue of stress tests--there was also the issue of liquidity coverage ratio, Pierret continued. “Silicon Valley was not also subject to the strongest liquidity coverage requirements,” she said. “If it was subject to it--the liquidity coverage ratio and the stress test--this would have been flagged a long time ago.”
“These three elements--the asset side risk, the liability side that is very specific in this case, plus the deregulation in 2018 that really cut the threshold just above Silicon Valley--is something that gave all the space for what we see happening,” said Pierret.
Could this happen in Europe?
It’s not easy to give a specific threshold for every European country, said Pierret, “but I can tell you already that a €200bn bank would be under subject to all the toughest regulation in Europe. One of the reasons is that there’s not been such a deregulation phase in Europe.”
Stress tests are also conducted differently. “For the strongest stress test in Europe--and there’s going to be one this year--they take the banks that represent 75% of the total assets of the banking sector,” Pierret explained. Luxembourg’s state bank Spuerkeess, which has €50bn in assets, is also included. SVB, therefore, would have been subject to stress tests as well.
“The liquidity coverage ratio--the liquidity requirements--it’s affecting even way more banks,” she added.
Any risk of consequences for Europe?
“In terms of interbank exposures--a direct form of contagion--I don’t see that much,” said Pierret. “And one of the reasons is the exposure limits that exist. As a bank, you cannot be exposed too much to a single named counterparty.”
“Again, the liabilities are completely different, and I think that’s the key,” said Pierret. “Look[ing] at uninsured deposits and uninsured deposits in a single industry, single region--I don’t see many banks like that, and definitely not the large banks. That’s a very different business model.”
Ironically enough, the Nobel Prize in economics in 2022 was awarded to Ben Bernanke, Douglas Diamond and Philip Dybvig for research on bank collapses, Pierret pointed out. “Which depositors are prone to running are mostly the uninsured depositors,” she said. “So the key ratio to watch these days is the ratio of uninsured deposits to total assets of a bank.”