Maria Ana Barata (EUI) and Christy Ann Petit (DCU)
The financial crisis ghosts are back since the failure of Silicon Valley Bank (SVB) in the United States started to preoccupy global financial supervisors seriously. Are Banking Union supervisors about to face their biggest nightmare?
What the SVB case has showed so far was not a failure of the crisis management and resolution tools by the US Federal Deposit Insurance Corporation (FDIC), but rather supervisory and regulatory failures from the US Federal Reserve System (FED). SVB was the 16th largest bank in the US, where it was considered a mid-sized bank. Even if this event did not trigger a banking crisis, looking at the FDIC data, this failure was larger – in assets – than the cumulated 157 bank failures in 2010 alone.
Since it had less than $250 billion of assets, SVB was classified as Category IV. The latter is one of the four categories of prudential standards that are based on the systemic risk and complexity attributes of a bank, under the ‘tailoring rule’ from the US Economic Growth, Regulatory Relief, and Consumer Protection Act (effective as of December 2019). Under these “Category IV standards”, SVB was not subject to some of the key elements of the Basel III reforms, in particular the ‘Net Stable Funding Ratio’ and the ‘Liquidity Coverage Ratio’ requirements. While the most stringent prudential requirements apply under Category I, the least stringent ones apply under Category IV. Relaxing the prudential standards by deviating from Basel III reforms opens the door to regulatory and supervisory failures. By being under a loosened Liquidity Coverage Ratio, SVB was more prone to enter a liquidity crisis, i.e., lack of sufficient cash inflows during an unusually high demand of deposit withdrawals.
In the Banking Union, SVB would very likely be classified as a Significant Institution under the direct supervision of the European Central Bank (ECB) within the Single Supervisory Mechanism. Even if that were not the case, the prudential requirements would equally apply. A hypothetical SVB in the Banking Union would have been subject to stronger rules and closer supervision than its real-life US counterpart – which would have resulted in higher prudential ratios.
SVB had an estimated $209bn worth of assets and $175.4bn worth of deposits – mainly constituted of corporate and business deposits above $250,000. When the collapse of SVB was announced, the FED felt pressure to restore confidence in the banking system. At this stage it is unclear whether financial stability concerns and/or political considerations made the FED change its course of action two days after the failure of SVB. In its initial position, the FED had announced that only insured depositors would be protected (i.e., up to $250,000) and that the deposits in excess would be lost. Later on, the FED shared a new view: all insured depositors will be protected as the FED recognised a full explicit guarantee of depositors.
What are the effects of the change of action of the FED towards SVB? Can it be considered an excessive measure kept for cases where systemic risk is at stake? Will the full guarantee of depositors generate moral hazard effects for future bank failures? Would the FED have reacted differently if the failure of SVB would affect retail depositors only?
By understanding that the collapse of SVB resulted from insufficient regulation and inefficient supervision, Banking Union supervisors, who apply effectively Basel III standards to all sizes of banks, should not fear any financial crisis ghosts.
Maria Ana Barata, EUI Florence School of Banking and Finance, Research Associate
Christy Ann Petit, Dublin City University (DCU) and Deputy Director, DCU Brexit Institute
Photo Credits: Sundry Photography/Stock.adobe.com
The views expressed in this blog reflect the position of the author and not necessarily that of the Brexit Institute Blog.