As banks collapse, regulators face retribution for a week of mayhem

(Bloomberg) — On Monday, the head of the Federal Deposit Insurance Corporation warned a gathering of bankers in Washington about a $620 billion risk lurking in the US financial system.

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By Friday, two banks had given way to him.

The question of whether U.S. regulators saw the dangers early enough and took sufficient action before the collapse of Silvergate Capital Corp. and the much larger financial group SVB, is now ready for a national debate.

The sudden demise of SVB – the largest in more than a decade – has left legions of Silicon Valley entrepreneurs in distress and fury. In Washington, politicians are uniting and Biden administration officials are expressing “full confidence” in regulators, while some observers are rushing to rethink plans to deal with past crises.

To his credit, this is not the first time FDIC Chairman Martin Grunberg has expressed concern in his speech this week that banks’ balance sheets are overflowing with low-interest bonds that have lost hundreds of billions of dollars in value due to the Federal Reserve’s rapid rate hikes. This raises the risk of a bank going bankrupt if the withdrawals force it to sell those assets and incur losses.

But despite his worries, the toppling of two California creditors in the middle of a single business week is in stark contrast to the years since the 2008 financial crisis, when regulators, including the FDIC, neatly seized hundreds of bankrupt banks after US trading closed on Fridays.

Even in the darkest moments of that era, the authorities managed to intervene in the affairs of Bear Stearns Cos and Lehman Brothers Holdings Inc. when the markets were closed for the weekend.

‘Blind area’

In this case, the watchdogs allowed the cryptocurrency-friendly Silvergate to limp for another work week after warning on March 1 that mounting losses could undermine its viability. Eventually, on Wednesday, the bank said it would close.

On the same day, SVB signaled that it needed to strengthen its balance sheet, fueling fears of a larger crisis. This was followed by the withdrawal of deposits and the arrest of the bank. The KBW Bank Index, made up of 24 major lenders, suffered its worst week in three years, falling 16%.

“There was a small regulatory blind spot with Silvergate,” said Keith Noreika, who served as Comptroller of the Currency in 2017. happen to others with similar funding disparities.”

FDIC and Fed officials declined to comment.

This drama is already causing controversy in Washington over the revision of the Dodd-Frank regulatory framework put in place after the 2008 crisis, as well as its partial rollback under President Donald Trump.

Trump eased the oversight of small and regional lenders when he signed a sweeping measure aimed at lowering their compliance costs. The measure, passed in May 2018, raised the threshold for being considered systemically important — a label imposing requirements including annual stress testing — to $250 billion in assets, up from $50 billion.

At the time, SVB had just hit the $50 billion mark. It had grown to $220 billion by early 2022, eventually ranking 16th among the largest US banks.

The lender has made much of this skyrocketing growth by absorbing deposits from red-hot tech startups during the pandemic and pouring money into debt securities.

As these businesses later burned funding and emptied their accounts, SVB made an after-tax loss of $1.8 billion for the first quarter, causing panic.

“A real stress test”

“This is a real stress test for Dodd-Frank,” said Betsy Duke, a former Fed chief who later chaired the board of directors of Wells Fargo & Co. “How will the FDIC allow a bank under Dodd-Frank requirements? Investors and savers will closely monitor everything they do and assess their own risk of losing access to their funds.”

One thing that could help: SVB needed to have a “living will”, offering regulators a map to wind down operations.

“The confidential settlement plan will describe the potential buyers of the bank, the components of the franchise, the parts of the bank that are important to the continued operation,” said Alexandra Barraj, a former senior FDIC official now with law firm Davis Wright Tremaine. “I hope this settlement plan helps the FDIC.”

The issues that turned both Silvergate and SVB upside down, including their unusual concentration of deposits from certain types of customers, were a “perfect storm,” she said. This can limit the number of problems that other firms face.

One complication is that the Fed has less ability to help banks with liquidity because it is trying to suck money out of the financial system to fight inflation.

Another is that the generation of bankers and regulators at the helm has not been held accountable during the recent period of sharp increases in interest rates, which makes it more likely that they will not anticipate developments as easily as their predecessors.

Indeed, for a time, even bank failures were rare. SVB has been the first since 2020.

“We are seeing the effects of decades of cheap money. Now our rates are growing rapidly,” Noreika said. “Banks shouldn’t have had to worry about that for a long time.”

–With the assistance of Jenny Suran.

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