Peter Morici: Silicon Valley Bank’s failure is no reason for stricter bank regulation

Silicon Valley Bank’s failure rattled confidence in small- and mid-sized banks across the U.S. and once again ignited cries to more tightly regulate banks.

That’s wrong-headed. We need to step back and examine how non-money center banks, which are essentially depositories, get into trouble and better apply the tools we have.

Ever since 17th century London goldsmiths invented modern banking by taking deposits of gold and sovereign coins and making loans by issuing transferrable notes, banks have provided a safer place to keep money than at home and more convenient methods for commercial transactions.

SVB catered to the needs of startup companies, their employees and founders with service and products specific to their needs. Reflecting the community’s values, SVB financed affordable housing, minority businesses and green energy projects.

These were not incompetent bankers. They had a solid loan book because they knew their community. Witness the considerable interest in purchasing SVB’s loan book by Apollo, Blackstone and others in the wake of its collapse.

Promising startups often attract funding in large bursts — initial seed capital and then cycles of private share sales — and deposit considerable sums at banks to cover expenses as they develop. They don’t borrow a lot relative to those deposits.

Consequently, at the end of 2022, SVB had just 35% of its assets invested in loans and more than half in U.S. Treasury and government-agency bonds.

During the tech boom of 2020 and 2021, interest rates were low and deposits rushed into the bank, but SVB purchased too many long-dated securities. After inflation accelerated and the Federal Reserve raised interest rates in 2022, the immediate resale value — as opposed to the par value — of those securities fell.

As stock prices fell in 2022, venture capital became scarcer and startups withdrew deposits from SVB to meet payroll and other expenses. As deposits fell, the situation was manageable but earlier this year withdrawals accelerated. SVB had to sell too many Treasury and agency securities below par and took losses.

On March 8, SVB announced a new stock offering to raise cash but on March 9, bank stocks had their worst day in almost three years. SVB stock lost 60% of its value. Peter Thiel’s Founders Fund and other venture capital funds advised their portfolio companies — the startups — to move their money, and the run on the bank became a torrent. This was hardly surprising because 94% of SVBs deposits exceeded the $250,000 cap. SVB tried to raise funds to accommodate the requests, but failed.

What was lacking to rescue SVB was a Federal Reserve facility to lend against SVB’s money-good Treasury and agency securities at par.

Closing the barn door after the cow escaped, the U.S. Treasury subsequently announced deposits above $250,000 at SVB and Signature Bank, which also failed, would be honored. The Fed established a one-year lending facility against Treasury and agency securities at par.

Had those steps been taken just four days earlier, SVB might have survived.

What’s needed is to remove the ceiling on deposit insurance for all banks and a Fed lending facility against the face value of good securities renewable for more than one year.

The moral hazard problem has two sides — the motivations of depositors and behavior of banks.

A depositor with $2 million in retirement savings, for example, should not have to check the bank’s balance sheet to safely deposit $500,000. And where should a business put its payroll account — spread over hundreds of banks to get the necessary insurance coverage?

Since 2006, Federal Deposit Insurance has been risk based, with premiums set according to the quality of assets on bank balance sheets.

If the FDIC properly sets rates — and bank examiners are diligent in their duties — it becomes like fire insurance. Covering risks over $250,000 creates moral hazard no more than insuring deposits below that arbitrary limit.

The banking system needs better-trained bank examiners — a competent official would have seen that SVB was overloaded with long-dated Treasurys. The bank’s Form 10-K reported that just $26 billion of its $120 billion in investment securities were marketable at par.

That was a fatal investment choice and SVB management should have been replaced, but letting the bank fail was a tragedy.

SVB made good loans based on its knowledge of the startup community. First Citizens Bancshares a North Carolina-based bank, is acquiring SVB’s banking functions but is likely to face difficulty replicating its service.

Peter Morici is an economist and emeritus business professor at the University of Maryland.