When Bryant University Professor of Finance Peter Nigro, Ph.D., examines the chaotic Silicon Valley Bank (SVB) collapse on March 10, he sees a number of issues: inadequate risk management at SVB, poor regulatory oversight at state and federal level, an inordinate amount of uninsured deposits, and regulatory rollbacks on banks greater than $50 billion — all of which resulted in the first internet-inspired bank run.
“Everybody should have seen this sooner, acted on it sooner, or at least tried to resolve it earlier,” says Nigro, who served as a senior financial economist in the policy analysis division at the U.S. Department of the Treasury’s Office of the Comptroller of the Currency for over a decade.
America’s second largest bank collapse, SVB is eclipsed only by Washington Mutual, which failed during the 2008 financial crisis. Last Friday, the Federal Deposit Insurance Corporation (FDIC) took control of SVB — leading federal regulators to take over the assets of New York’s Signature Bank, which had a similar number of uninsured deposits as SVB and regulators wanted to prevent another bank run.
Understanding the collapse
Over the last two years, Nigro explains, the level of deposits at SVB, primarily by venture capital firms and tech startups, increased rapidly. Given the large influx of deposits — and relatively few loan opportunities — the bank’s investment portfolio was unusually large. SVB invested in “riskless” longer term Treasurys and Agency mortgage-backed securities to earn higher yields, but risk is multi-dimensional and interest-rate risk took the bank down, says Nigro.
But why did so many people miss the brewing financial storm at SVB? SVB’s balance sheet was a fairy tale, Nigro says; once upon a time, its assets were worth what they were carried out. The Federal Reserve’s increase in rates over the last year greatly reduced the market value of SVB’s investment portfolio — about $15.9 billion in unrealized losses in the third quarter compared to the company’s $11.9 billion of tangible common equity. This did not become an issue until SVB was forced to sell some of its $21 billion investments at a loss, which concerned investors but, significantly, spooked uninsured depositors via the internet and led to a run.
“They should have been match-funding — or at least, in some way, hedging that interest rate risk,” Nigro says, “It’s banking 101.”
Nigro adds that SVB’s internal rate of return should have been addressed during SVB’s last regulatory examinations, which occur every 12 to 18 months. State and Fed regulators, he says, will have a lot of explaining to do.
Although, Dodd Frank required banks above the $50 billion threshold to undergo a stress test to assess if they have enough capital to withstand shocks to the system, in 2018 it was increased to $250 billion. SVB was below this threshold (220 billion) and did not require a more stringent stress test.
After the 2008 Global financial crisis in 2008, regulations were put in place to mitigate future occurrences and “eliminate” systemic risk.
According to Nigro, in 2008 several large banks were insolvent — and subsequently were bailed out by the Treasury due to systemic risk concerns. In 2023, SVB was allowed to fail – but uninsured depositors were made whole – they did not lose money. Although the FDIC is required to resolve bank failures in the least cost method to the Deposit Insurance Fund, policymakers invoked the invoked the “systemic risk” exception to make bailout to the uninsured depositors at SVB depositors. This was done to avoid runs at similar regional banks by uninsured depositors.
“It is, however, a policy failure and shows that despite protestations about more regulation, some regional banks are systemic in nature,” Nigro says.
Is history repeating itself?
Not everyone was surprised by the SVB collapse and resulting panic. Nigro points to a 2019 Brookings Institution panel on regional bank resolution, in which U.S. Federal Deposit Insurance Corporation Chair Martin Gruenberg discussed how a regional bank’s size, complexity, and reliance on short-term funding can have systemic consequences — a foreshadowing of what happened at SVB.
After the financial crisis in 2008, when several large banks were bailed out by the Treasury so they didn’t take down the entire banking system, regulations were put in place to “eliminate” systemic risk, requiring banks above the $50 billion threshold to undergo stress tests to assess if they have enough capital to withstand shocks to the system. But, in 2018, the threshold was lowered to $50 billion. At $220 billion, SVB was not subject to a more stringent stress test.
To be sure, SVB was allowed to fail and shareholders are projected to lose $850 million collectively. But both insured depositors — with up to $250,000 in the bank — and uninsured depositors will not lose money. Although the FDIC is required to resolve bank failures in the least costly method to a deposit insurance fund supported by big banks, policymakers invoked the “systemic risk” exception to bail out both insured and uninsured SVB depositors, Nigro says. This was done to avoid runs at similar regional banks by uninsured depositors. Even midsize regional banks, Nigro says, are “too big to fail” under current regulatory conditions.
“It’s a policy failure and shows that despite protestations about more regulation, some regional banks are systemic in nature,” Nigro says.
Nigro says we should expect tighter regulatory oversight and rules for regional banks going forward.
“I think we're going to see further consolidation of the industry through some, maybe one or two, more failures – but also through mergers,” says Nigro, adding that the ordinary person doesn’t need to panic — particularly those who rely on smaller community banks and won’t meet the $250,000 threshold for uninsured deposits.
Nevertheless, Nigro believes regional and community banks will be subject to new regulations. He also believes the shadow banking system — where unregulated institutions engage in financial activities — will continue to grow.
“We have to think about a way to ensure that this doesn't happen, rather than dealing with these issues after the fact,” he says.
Since a bank’s biggest asset is customer trust, a crisis like this reduces confidence in the banking system. Nigro says the reputations of California and the Fed are likely to take a hit.
Moving forward, the Justice Department, the Securities and Exchange Commission, and the Federal Reserve have committed to investigate. On Monday, President Joe Biden stressed that the banking system is safe. However, the very next day, Moody’s Investors Service changed its outlook on the U.S. banking system from stable to negative to reflect rapid deterioration, and fears of contagion, within the sector.