Monday, Mar 20, 2023
TC Insights - Supervisory Lessons from the Failure of Silicon Valley Bank
This is the third lesson for financial supervisors from the failure of Silicon Valley Bank (SVB)[1]. Download the document above to see all lessons. Other TC Insights can be found in the News section of our website.
Many of these lessons are applicable to supervisors of all types of financial institutions, not just banks.
“Bank runs are a common feature of the extreme crises that have played a prominent role in monetary history. During a bank run, depositors rush to withdraw their deposits because they expect the bank to fail. In fact, the sudden withdrawals can force the bank to liquidate many of its assets at a loss and to fail.”
Douglas W. Diamond and Philip H. Dybvig, 1983
Lesson 3 – Deposit Risks
One lesson from the Global Financial Crisis of 2007-2009 was that some banks had relied too heavily on wholesale funding. But, as SVB illustrates, funding risks can take many forms.
SVB was funded predominantly from customer deposits. These grew very rapidly during 2021, and by the end of 2021, non-interest-bearing demand deposits from customers had reached $126 billion, with customer interest-bearing deposits of $5 billion and money market funding of $57 billion.
Four characteristics of these customer deposits were problematic.
- They were deposited by a relatively small and concentrated depositor base of venture capitalists and technology companies. These depositors were cash-rich as a result of a pause in investment and the receipt of government loans and funding during the COVID-19 pandemic.
- They were mostly non-interest-bearing on-demand deposits.
- Nearly all (up to 95%) of them were above the $250,000 coverage limit of the deposit insurance scheme (the FDIC).
- They were easily accessible and movable 24 hours a day, every day, through mobile phone applications and internet-based accounts.
All these characteristics increased the “flight risk” of these customer deposits. They were held by depositors from a relatively close community where news, rumours and actions could, and did, spread rapidly. Depositors could literally withdraw their deposits as quickly as they had made them, either because they needed the cash or because of any concerns they had about SVB. The large size of the individual deposits meant that deposit insurance provided only very limited potential benefit. And the zero rate of interest meant that switching to other banks became increasingly attractive when interest rates began to rise.
As Diamond and Dybvig (recent Nobel Prize winners) demonstrated in an academic paper 40 years ago, it is rational to “run” from a bank at the slightest sign of trouble because you never know (a) whether the bank will be solvent, or (b) what everyone else will do. Being the first out of the door is better than taking the risk of not being able to exit at all.
More generous deposit insurance and the post-Global Financial Crisis regulatory reforms may have reduced the incentive to run, but clearly they have not removed it entirely. And, as shown by the recent experience of Credit Suisse, serious funding problems can threaten even a systemically important financial institution subject to additional capital requirements, higher expected standards of governance and risk management, more intensive and intrusive supervision, and recovery and resolution planning.
As bad news about SVB emerged, including a failed attempt to raise new capital, customers tried to withdraw $42 billion in deposits from the bank on 9 March 2023, equivalent to a quarter of its overall deposit base. Whether solvent or not, the bank had to close.
[1] This series of TC Insights is written by Clive Briault, Chair, Toronto Centre Banking Advisory Board.
For more information, please contact:
Judy Shin
Communications Lead, Toronto Centre
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