Individuals are thought to behave rationally, an assumption that underpins standard economic theory as we know it today. Yet, mainstream economics has been increasingly called into question when it comes to investor behavior in times of crises. To many Americans, the term “bank run” conjures up the imagery of a mob of investors crowding at the entrance of banks in a usually futile attempt at retrieving their deposits in the days of the Great Depression. In the face of such an unprecedented shock, deposit insurance (whereby every depositor’s funds will be insured up to a certain limit in the event of a bank insolvency) began to be offered by the Federal Deposit Insurance Corporation (FDIC) in 1933, aimed at restoring battered market confidence in the US banking system. Yet, bank runs returned in the subprime mortgage crisis of 2007 - 2008 and again in 2023. While a handful of small banks do fail annually, it is definitely far from the norm to see 2 mid-sized banks seized by the FDIC and a 3rd declare bankruptcy within a span of 2 weeks. Bank runs were the proverbial final straws that broke the camels’ back in all 3 cases, but what went wrong in the first place?
Image Credit: Forbes
Silvergate Bank
A small community bank founded in California back in 1988, Silvergate remained in relative obscurity until CEO Alan Lane’s decision to venture into the crypto scene in 2016. Due to regulatory complexities, virtually all traditional financial institutions shun the ill-regulated, highly volatile sector. However, that was not the case for Silvergate, where exponential growth soon followed when crypto firms around the world deposited billions. This was followed by the game-changer in 2017 known as the Silvergate Exchange Network (SEN), the bank’s flagship offering that bridges the gap between crypto and fiat. Essentially a 24/7 instant settlement network, users of SEN could move US dollars between Silvergate bank accounts and affiliated crypto exchanges within minutes even during non-banking hours. Unfortunately, the bank’s severely understaffed compliance team was simply unable to keep up with the torrential transaction volumes. Soon, it was saddled with accusations that SEN facilitated money laundering, various types of fraud and even acquired the nickname as the go-to bank for criminals of the digital world.
Beginnings of the End
“An utter failure of corporate controls at every level of an organization, from the lack of financial statements to a complete failure of any internal controls or governance”
~John Ray III, principal liquidator of FTX
Late 2022’s crypto winter saw the spectacular collapse of Bankman-Fried’s crypto exchange FTX coupled with plunging crypto prices across the board. Naturally, the implications on Silvergate were scrutinized given its closely intertwined nature with the crypto world. The trickle of withdrawals soon grew as more crypto firms and exchanges sought to shore up their own balance sheets amid widespread panic over the future of crypto on a whole. Crypto clients were further spooked when Silvergate revealed that it was facing extensive difficulties sustaining operations in an announcement ahead of its annual report release. This led to crypto heavyweights such as Coinbase Inc and Blockchain.com ceasing their platforms’ support of SEN with immediate effect. A voluntary liquidation announcement followed days after on March 8, bringing an end to the sole “non-traditional” financial institution in recent years.
Thankfully, the fallout from Silvergate’s demise was largely limited to the crypto sector (unlike what we will subsequently see in SVB and Signature). Vocal crypto hawks such as senator Elizabeth Warren weighed in on the collapse and called for even stricter regulatory scrutiny beyond what is currently mandated under the Dodd-Frank Act (elaborated on later). Some went one step further and questioned why regulators had not stepped in earlier to restrain a federally-insured bank from dabbling in the extreme volatilities of crypto.
Goodbye to Silicon Valley Bank, Darling of the Startup Scene
Making matters worse, the almost simultaneous collapse of the Silicon Valley Bank (SVB) on Friday, the 10th of March in 2023, was the largest bank failure since the financial crisis during 2007-2008 and further roiled the already highly jittery markets. In order to understand what led to 3 banks collapsing within such a short span of each other, let us rewind back to March of 2022, slightly over a year ago. The coronavirus was receding in America and in its place, inflation was rearing its ugly head. Thus began a series of rapid interest rate hikes by the Fed, a tried and tested strategy in place to tame inflation since the Volcker shocks of October 1979. Given the inverse relationship between the Fed interest rate range and Treasury bond prices, the meagre returns on investments in short-term Treasury bonds were no longer viable for many commercial banks, both Silvergate and SVB amongst them. In other words, bond values (regardless of maturity date) go down when the Fed interest rate goes up. It is also important to note here that longer-term bonds (10 or 30 years’ maturity) typically are more sensitive to Fed interest rate changes as compared to short-term 2 year bonds in what is known as the “duration risk”.
Image Credit: Investopedia
Given that long-term Treasury bonds formed around 80% of SVB’s securities portfolio by early 2023, there was no cause for concern during ‘normal’ times - Treasury bonds are fully backed by the full faith and credit of the US government with the principal payable upon the maturity date. However, the prevailing market price of the bond is never guaranteed before maturity and can be subject to wild price fluctuations in the meantime. With Fed rate hikes continuing at the rapid pace even up till February 2023, it was far from a ‘normal’ time either. Herein lies the recipe for disaster: SVB took on increasingly large losses when it had to liquidate its holdings of long-term bonds to satisfy client withdrawals.
Combined with a poorly-worded announcement that did exactly the opposite of its intent (to calm investors), SVB was swiftly caught up in the throes of a classic bank run as unsubstantiated rumors of its impending doom spread rapidly among members of the tight-knit tech startup scene that formed the bulk of SVB’s clients. By late Friday March 10, SVB walked into history books as regulators seized the assets of the troubled financial institution.
Yet Another Casualty: Signature Bank
An unsettling parallel can be seen in the seizure of Signature Bank by the FDIC, merely 2 days after SVB’s demise. It too was a full-service financial institution that similarly dabbled in crypto assets since 2018, offering a service that allowed clients to directly deposit their crypto assets for close to real-time settlement. More ‘traditional’ clients include taxi medallion holders and the provision of escrow services to law firms. Again, the ill-fated decision to serve digital asset clients meant that the ongoing crypto winter severely dented Signature’s bottom line in recent months. Despite a torrential outflow of deposits appearing to slow down as the weekend approached, regulators - concerned with the contagion effects of yet another collapse - moved in to seize Signature’s assets and dismissed its management on Sunday, 12 March, citing “a significant crisis of confidence in the bank’s leadership.
Trouble in Switzerland
Murmurs of panic quickly rippled across the Atlantic and found its target in Credit Suisse, a 166-year old investment behemoth. As a systematically important bank, it had the healthiest balance sheet and routinely topped global private banking rankings. However, a consecutive series of regulatory missteps and investment blunders cost the bank billions in losses that proved damaging and by 2023, Credit Suisse was reduced to a mere shadow of its former self. A wave of executive resignations did little to reassure investors especially after the folding of Greensill and Archegos Capital in 2021. With stock prices plunging below 3 CHF to reach lows in early February, gnawing doubts started to form: was Credit Suisse in danger?
In an eleventh-hour deal brokered under pressure from the Swiss authorities, rival UBS was to acquire Credit Suisse for US$3.2b, bringing an end to the latter’s illustrious past as the financier of the Swiss rail network back in the 19th century. While the details are not confirmed yet, UBS reportedly intends to downsize parts of Credit Suisse and a new wave of retrenchments is to be expected.
The Fed's Conundrum
As widely expected, the ripple effect soon spread to other mid-sized US banks that also experienced the beginnings of their own bank runs and stock price crashes. For instance, the stock of First Republic Bank (the 14th largest US bank by asset size) has plunged by more than 80% since early March. More worryingly, a US$30b emergency bailout assembled from some of Wall Street’s largest names failed to reverse the precipitous decline in its stock. The future remains uncertain as the Fed has explicitly ruled out insuring all currently uninsured depositors’ funds beyond the current US$250,000 limit per depositor.
Time | Interest Rate Range |
2022-03-17 | 0.25%~0.5% |
2022-05-04 | 0.75%~1.0% |
2022-06-16 | 1.50%~1.75% |
2022-07-28 | 2.25%~2.50% |
2022-09-22 | 3.00%~3.25% |
2022-11-03 | 3.75%~4.00% |
2022-12-15 | 4.25%~4.50% |
2023-02-02 | 4.50%~4.75% |
Credit: Forkast/ Winston Hsiao
Days after the collapse of SVB and Signature, the Fed has opted to proceed with a small rate hike by 0.25% instead of scrapping the 9th increase in 2 years. However, the Fed has also acknowledged that it would reconsider its monetary policies amidst growing accusations that its swift and excessive interest rate hikes left little room for banks to maneuver and ultimately played a significant role in creating the banking crisis of 2023. Concerns over a wider contagion effect were downplayed by Fed chair Jerome Powell, who repeatedly emphasized the soundness of the US banking system as compared to the chaos 15 years ago. Yet, even such forward-looking statements failed to fully pare losses especially for banking stocks.
The Regulatory Blind Spot
As we enter an uneasy normalcy, some have questioned the role played by US regulators in the current banking crisis (or rather, the lack thereof). Passed in 2010, the Dodd-Frank Act was supposed to ensure that the recurrence of a similar banking crisis would be close to negligible by significantly expanding regulation concerning the financial industry - specifically bank stress tests and capital requirements. This meant that all financial institutions holding more than US$50b were considered “systematically important” and as such, subject to mandatory regular stress tests. Ironically, SVB’s CEO Greg Becker was one of the most vocal critics of the law back in 2015 and repeatedly lobbied for the loosening of rules, claiming that unnecessary compliance costs incurred could stifle the mid-sized banks. Trump’s ascent to the presidency a year later meant that Becker’s requests were largely fulfilled through a partial rollback of Dodd-Frank requirements: the US$50b threshold was lifted to US$250b. As the ashes of SVB settles, many wonder if the costly collapse could have been avoided if it had undergone the necessary stress tests that would have laid bare any shortfalls in SVB’s risk management. To his credit, the Biden administration is now considering a belated reinstatement of Dodd-Frank requirements, but is it too little, too late?
References
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DiCamillo, N. (2023, March 8). Crypto Bank Silvergate is winding down, becoming another domino in the FTX collapse. Quartz. Retrieved from https://qz.com/crypto-bank-silvergate-is-winding-down-becoming-anothe-1850205067
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Hsiao, W. (2023, March 17). What caused Silvergate and Silicon Valley Bank to fail? Forkast. Retrieved from https://forkast.news/what-caused-silvergate-svb-bank-fail/
Levitt, H., Johnson, K., & Doherty, K. (2023, March 11). SVB CEO Greg Becker lobbied the government to relax some Dodd-Frank Provisions on regional lenders in 2015. trump did in 2018. Fortune. Retrieved from https://fortune.com/2023/03/11/silicon-valley-bank-svb-ceo-greg-becker-dodd-frank-trump-rollback-systemically-important-fdic/
Reyes, M. (2023, March 14). Signature bank (SBNY) was seized after 'crisis of confidence' in management. Bloomberg.com. Retrieved from https://www.bloomberg.com/news/articles/2023-03-14/signature-was-seized-after-leaders-caused-crisis-of-confidence
Root, A. (2023, March 14). Why signature bank failed. Why Did Signature Bank Collapse? Inside the Failure. | Barron's. Retrieved from https://www.barrons.com/articles/signature-bank-shut-down-collapse-a0adf63f
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Schneider, H., Bahceli, Y. B., & Sharma, A. (2023, March 23). U.S. fed delivers small rate hike amid global banking turmoil. Reuters. Retrieved from https://www.reuters.com/business/finance/us-banks-face-scrutiny-fed-rate-decision-looms-2023-03-22/
Wright, D. (2023, April 2). In an era of social media fuelling bank runs, good communication is more vital than ever. South China Morning Post. Retrieved from https://www.scmp.com/comment/opinion/article/3215313/era-social-media-fuelling-bank-runs-good-communication-more-vital-ever?module=opinion&pgtype=homepage
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