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Silicon Valley Bank (SVB)—the 16th largest bank in the United States—was shut down by federal regulators on March 10, 2023. Here are 9 things I learned from the recent banking crisis.

9 Things I Learned from SVB

  1. Silicon Valley Bank was very large, with about $200 billion in total assets. It was the 16th largest bank in the U.S.

  2. Banks have an interesting way of accounting their assets. Banks designate certain assets on their books as “available for sale”, those which they expect to perhaps sell to raise liquidity, and “held to maturity.” Losses in the AFS portfolio are relatively noisy, because they immediately ripple into one’s income statement, are reported quarterly, and are extremely salient for all stakeholders. Losses in the HTM securities are basically fine until they aren’t.

  3. The whole point of banks is maturity mismatch — to borrow short and lend long. There are two follow-up questions that emerge:

    1. Is it optimal for this mismatch to sit with the banks? This mismatch must exist somewhere; the alternative is a much poorer and riskier world. Some of the mismatch sits outside the banking system through securitizations and shedding them off the bank balance sheet.
    2. Does maturity mismatch necessarily require duration mismatch? Even among academics, this is an open question. See bullet #9.

  4. Importance of deposit franchise. Deposit franchise refers to the ability of the bank to attract and retail stable and low-cost deposits from customers. Naturally, it serves as a hedge for banks as long as the deposit franchise remains robust.

  5. Social media can “wake” depositors up. It can happen through (1) spread of panic, (2) revealing of unethical behavior, (3) influence form financial gurus and influencers, and (4) easier access to alternative financial systems.

  6. Agency problems matter. In the case of SVB, the compensation of executives was heavily geared towards return on equity over a 1- to 3-year-period. This created an incentive to find sources of short-term profits in order to keep returns on equity up when rates were low.

  7. Why did SVB not hedge? There seem to be three types of answers:

    1. Profitability: SVB aimed for higher profits by investing in long-term bonds instead of hedging to short-term rates. They briefly used hedges in 2022 but removed them for increased profits.
    2. Perceived Stability of Deposits: SVB viewed its deposits as long-term funds due to their strong customer relationships and policies for startups to maintain deposits.
    3. Accounting and Regulatory Considerations: If SVB hedged and rates went down, the fluctuations in value of its interest-rate swap would have created a large loss, impacting their reported financial results and regulatory capital. The accounting rules did not allow hedging of held-to-maturity assets, and hedging could have made SVB's financial results and regulatory capital appear more volatile, damaging the bank's perceived stability.

  8. The regulators seem to have been aware. In an internal February Fed report (later released to the public) on interest rate risk in the banking sector, they mention SVB as a stylized example.

  9. There is still no consensus on the theory of banking. The IGM Finance Panel suggests a strong disagreement with respect to the following question:

    <aside> 💡 “Since maturity transformation is an inherent feature of commercial banks' business model, some duration mismatch between assets and liabilities is unavoidable.”

    </aside>

    Key question: does maturity mismatch necessarily imply duration mismatch?