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The Failure of Silicon Valley Bank – Are There Lessons for the Basel Regulatory Framework?

Bretton Woods Committee  | Fri, Mar 24, 2023

by Anthony Elson


The collapse of Silicon Valley Bank (SVB) on March 10 was a failure that should not have occurred. A confluence of factors involving regulators, SVB management, and its depositors came together in an adverse way to bring down the bank.

Starting with SVB management, it is now clear that it was dealing with a particularly risky version of the maturation risk that all banks confront in the sense that they borrow short and lend long. In the case of SVB, an unusually high percentage of its demand deposits (nearly 90 percent) were uninsured by the FDIC because its depositors (mainly venture capital firms in Silicon Valley) had large value accounts well in excess of the FDIC ceiling of $250,000. On the asset side, somewhat less than half of SVB’s investments were highly concentrated in risky loans to high-tech and venture capital firms in Silicon Valley, reflecting SVB’s valued role in that sector.

The other large share of SVB’s assets were in the form of government-backed mortgage-backed securities and Treasury bonds. All of these assets were long-term in nature and had been purchased before the recent increases in interest rates by the Federal Reserve. Most of these securities were classified as “hold-to-maturity” which allowed SVB to value these on its balance sheet at face value, as distinct from the much smaller share of its “available for sale” securities. The latter share was marked for sale to deal with liquidity needs, but had lost significant value since the time of their purchase because of the large increase in market interest rates since the middle of last year. Even at face value, these securities were only a small share of the amount of uninsured deposits at the end of 2022.

In dealing with the risky elements of its balance sheet, SVB management was not taking adequate steps to hedge against the interest rate risk of the government asset portfolio just described. Any interest rate swaps that it had at the end of 2021 to hedge against that risk were allowed to lapse during 2022 according to its most recent Form 10K report to the SEC. In addition, according to newspaper reports, it appears that the position of its chief risk officer had been vacant during most of last year. The degree of interest rate risk on the balance sheet of SVB can be gauged by the estimate provided by KPMG’s financial audit report for 2022, which showed that the unrecognized losses of SVB’s government asset portfolio amounted to $17.7 billion or 96 percent of its capital base (10Kreport). 

According to recent newspaper accounts, bank supervisors in the San Francisco Fed were concerned about SVB’s interest rate risk position and had issued warnings to SVB management about this situation and the poor risk management actions it had taken to deal with it. However, as a result of actions taken by the Fed in 2018 based on Congressional approval, the threshold for the most rigorous degree of supervisory review had been lifted from banks with an asset value of $50 billion to those with an asset value of $250 billion, which excluded SVB. As a result, it was exempt from the regular stress tests on its capital base and liquidity coverage that the larger banks must perform. In any event, SVB’s capital base was above the thresholds set by the Basel III requirements and, according to a recent study by the Bank Policy Institute, it also appears that it would have been in compliance with the Basel liquidity coverage requirements (BPI). If so, the LCR probably needs some regulatory review.   

In the light of these facts, it also seems prudent to ask if the standard measure of risk-weighted capital adequacy in the Basel requirements should be changed. At present, this measure only takes account of the degree of credit risk associated with the credit quality of a bank’s asset portfolio. Thus, a bank such as SVB, with a large share of its portfolio in government or government-backed securities with very low credit risk, would be judged to have a much stronger capital base than a bank with a smaller share of its portfolio in these securities. However, broadening the measure of risk-weighted capital adequacy to include SVB’s interest rate risk would have yielded a much weaker measure of its capital adequacy. Had such a measure been applied to SVB, supervisors could have insisted that it strengthen its capital base much sooner that it attempted to do so just before the depositor panic began. 

Mr. Elson is a former senior staff member of the IMF and the author of a number of books on global economic and financial issues including, most recently, The Global Currency Power of the US Dollar – Problems and Prospects (2021).

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