The Systemic Nature of the Current Banking Crisis
The current crisis isn’t isolated to a few institutions; it’s systemic. Many banks adopted similar strategies—rapid deposit growth during periods of low interest rates followed by investments in fixed-income securities—leaving them vulnerable when interest rates rose. SVB’s rapid growth and subsequent collapse serve as a stark example. The bank’s deposit base tripled between 2019 and 2022, fueled by large uninsured corporate deposits, while lending lagged. Excess deposits were invested in seemingly safe government bonds and agency debt. However, these ‘safe’ assets lost significant value when the Federal Reserve began raising interest rates in 2022.
Figure 1: SVB’s rapid balance sheet growth from 2019 to 2022.
Hidden Insolvency and Regulatory Oversights
SVB’s insolvency, masked by accounting practices that didn’t require recognizing losses on “held-to-maturity” (HTM) assets, went largely unnoticed by regulators. The Federal Reserve’s own report on SVB acknowledges management recklessness and supervisory failures, highlighting a “light touch” approach to regulation. Crucially, regulators failed to adequately address the interconnectedness of interest rate and liquidity risks, both exacerbated by rising interest rates. The focus on capital ratios based on accounting valuations, rather than market values, further obscured the true extent of the problem.
Parallels to the S&L Crisis
The current situation mirrors the S&L crisis, where institutions, facing similar liquidity issues, engaged in risky behavior to recoup losses, ultimately leading to a costly taxpayer bailout. Today, the Federal Reserve’s liquidity support, while providing temporary relief, doesn’t address the underlying solvency problems. Banks relying on high-interest borrowing to repay depositors or attract new ones are merely delaying the inevitable.
Addressing the Solvency Problem: When Will They Learn?
Ignoring insolvency while insuring deposits is a recipe for disaster. Instead of focusing on short-term fixes, authorities need to acknowledge the systemic nature of the crisis and implement meaningful reforms. Possible solutions include stricter executive compensation restrictions for at-risk banks, facilitating mergers among smaller institutions (avoiding further consolidation of “too-big-to-fail” banks), and critically, applying fair-value accounting to all assets.
Figure 2: Potential impact of uninsured depositor runs on bank solvency.
Long-Overdue Regulatory Reforms
To prevent future crises, regulators must:
- Implement Fair-Value Accounting: Recognize the true value of assets, eliminating the illusion that changes in fair value of HTM assets are irrelevant.
- Acknowledge Risk Correlations: Understand the interconnectedness of various risks, particularly those stemming from macroeconomic changes.
- Strengthen Supervision: Actively monitor and intervene in cases of excessive risk-taking, such as the extreme maturity transformation seen at SVB.
- Increase Equity Requirements: Ensure banks have sufficient capital to absorb losses without relying on government intervention.
The recurring nature of banking crises underscores a frustrating truth: despite repeated failures, the lessons learned often fade with time. The current crisis presents an opportunity for real change. Implementing these long-overdue reforms is crucial to ensuring a more stable and resilient financial system. The question remains: when will they ever learn?
References
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