SVB-Fueled Turmoil Junks Lessons of the Global Financial Crisis

Fed, Congress thought smaller banks, deposits and bonds were boring and safe; instead, they are the source of new fragility

By Greg Ip of The WSJ. Excerpts: 

"Banks are supposed to be safer than shadow banks because they are tightly regulated. So how could the Fed, which shared oversight of SVB with California regulators, let this happen? The situation was hardly unprecedented: A mismatch between long-term loans and short-term deposits brought down many savings-and-loan institutions when interest rates soared in the late 1970s and early 1980s. Reliance on uninsured deposits precipitated the collapse of Continental Illinois in 1984 and Bank of New England in 1991.

Conceivably, Fed regulators, like their monetary-policy colleagues, were caught off-guard by how much interest rates would rise because of inflation. Such a scenario wasn’t in the stress tests administered to the much larger global systemically important banks (GSIBs). Even so, banks should have tested for such a scenario on their own.

Fed supervisors also thought, wrongly, that uninsured deposits were a safe form of funding. “Long experience has taught supervisors and regulators that uninsured deposits from your customers, as opposed to brokered deposits or wholesale short term funding, are rather stable,” said Randal Quarles, who oversaw regulation at the Fed as a governor until 2021. That assumption needs to be rethought, he said.

Regulators and legislators thought the global financial crisis showed small and regional banks were inherently safer than GSIBs. Smaller, simpler and less interconnected, they wouldn’t take down other institutions if they failed. That rationale led Congress to raise the asset-size threshold at which tougher capital and liquidity requirements kicked in to $250 billion from $50 billion in 2018."

"regulations only matter if examiners are enforcing them, and supervisors still had a lot of powers to discipline smaller institutions. While Fed examiners did alert SVB’s management as far back as 2019 with their concerns, they didn’t, it appears, take more severe steps such as forcing them to turn away deposits or raise capital. That is despite multiple red flags such as rapid growth, high dependence on uninsured deposits from concentrated sectors, large deposits tied to venture-capital deals and no chief risk officer."

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