But SVB was no regular bank. Nor was it regulated like one. SVB mostly had one type of customer (a finance director) working for one type of business (a startup) parking one type of deposit (the venture capital needed to fund the business). Rather than generate cash, startups burn it. That makes it difficult to borrow money. SVB was different. It was prepared to lend money provided the startups put their venture capital in its deposit account. SVB then put this money into long-dated government bonds. US accounting rules stated that if these were held to maturity then all was well. But selling them before maturity, when prices were down, would hit the bank’s capital buffers hard. And that’s what happened. When SVB tried to raise fresh capital (by issuing more shares) more depositors fled – all at once. It was game over.
People said that regional regulators in California needed to have better oversight. And they were right. One member of the Federal Reserve Bank of San Francisco board of directors was also the chief executive of SVB. Don’t worry, he isn’t now. But during his time on the board, he had pushed for a relaxation of stress tests on regional banks – including SVB.
The US has a two-tier system for regulating banks. The giants are required to be strongly capitalised and are subject to severe stress tests to check this. However, the US has dozens of smaller, regional banks whose regulation is much less strict. That’s because, individually, none is regarded as posing a systemic risk to the financial system. Thanks to the ability of social media to spread fear faster than a Californian wildfire, we now know that’s no longer strictly true.
Following the 2008 banking crisis, US regulators encouraged banks to hold government bonds as these were regarded as highly liquid assets that could not go bust and were therefore safe. However, quite amazingly, the banks’ annual stress tests did not incorporate scenarios where US interest rates rose to much higher levels. Which is what has happened.
Bond vigilance
As you know, Fed Chairman Jay Powell has been relentlessly raising US interest rates without pausing to see what side effects these actions might have – or Operation Stable Door as it is unofficially but accurately known. One major effect is that when interest rates rise, the yields on bonds rise with them – which means the capital values of the bonds fall. The maths is such that the longer-dated the bonds, the sharper is the decline in bond prices when interest rates are rising.
