California looks at banking reform after Silicon Valley Bank failure
Natalie Hanson
(CN) SACRAMENTO, Calif. (CN) — California lawmakers took up the issue of bank regulation reforms Monday in the wake of the largest bank run in U.S. history at Silicon Valley Bank and the failure of New York-based Signature Bank in March.
The California-based Silicon Valley Bank, a key lender for tech startups, announced plans in March to sell a large amount of investments at a loss to shore up its balance sheet. The announcement triggered a panic from venture capital firms, which reportedly advised companies to withdraw money from the bank, causing the company's stock to crater.
The $212 billion in assets reported by Silicon Valley Bank in the fourth quarter of 2022 made its collapse the second-largest in U.S. history after Washington Mutual, which went under with $300 billion in assets at the height of the 2008 financial crisis.
On March 13, President Joe Biden stressed that the bank’s management will be fired and those who had deposits will have access to their money through the FDIC’s Deposit Insurance Fund, a more than $100 billion reserve funded by the fees that banks pay and the earnings on their investments such as Treasury securities.
Then on March 17, Biden said there must be stiffer laws to hold bank executives accountable. The White House said the FDIC, the U.S. Securities and Exchange Commission and the Justice Department are investigating the circumstances leading to the bank collapses. The administration wants stronger rules for regulators to recoup compensation from executives, broader range to impose civil penalties and stronger authority to bar executives from returning to work in the industry.
California Assembly members heard from experts in a Banking and Finance committee hearing Monday about what Silicon Valley Bank’s collapse could mean for California's approach toward banking regulation.
Todd Baker, senior fellow at Columbia University’s Richman Center, said the bank’s failure came from a long period of very low interest rates and high growth in the tech economy — “a Goldilocks period.”
Founded in the 1980s, the bank had a uniquely “undiversified” risk profile focused on the tech industry, and became the largest state-chartered bank. Its stock rose and fell with the tech industry’s successes and failures, making for a volatile deposit base.
Baker said interest rate hikes by the Federal Reserve coincided with a declining tech economy, and investors began rapidly pulling their money out of the bank. He blamed the bank’s “poor risk management” on a board that lacked expertise and tried to play the “yield curve” — betting on interest rates and ignoring high deposit volatility — to increase earnings. Nearly 94% of domestic deposits were uninsured. Worse, there was no chief risk officer for months and the bank didn’t shorten the securities portfolio duration during rate hikes, therefore being unprepared for liquidity runs.
When Goldman Sachs purchased the discounted securities portfolio on March 8, the bank saw a $1.8 billion loss the same day cryptocurrency leader Silvergate Bank announced it would voluntarily liquidate and close.
This helped cause “the worst bank run in U.S. history” with $42 billion gone in one day and $100 billion heading out the door, Baker said.
He added that lawmakers should consider if bank boards must have experts, if the bank’s management should be banned from future industry involvement and if regulators have the right powers.
Michele Alt, partner at financial services advisory firm Klaros Group, told lawmakers that they must ask what the California Department of Financial Protection and Innovation knew and when, and investigate the “complete debacle” of public messaging around the bank run.
Assemblymember Diane Dixon, a Republican from Newport Beach, asked if there should be regulatory enhancements because the bank lacked a chief risk officer. Baker said enhancements are needed and lawmakers should ask how the bank went so long without one.
Alt said every banking crisis has led to discussions of simplifying the regulatory system, but instead new regulations are created since no agency wants to relinquish power. She suggested looking at how executives receive financial incentives compared to performance measures.
“It’s always worth asking, are you solving the problem you set out to solve?” she said.
Assemblymember Tim Grayson — a Concord Democrat and committee chair — said Sacramento could consider if the bank failure could mean changes to the state’s charter to address competitiveness, and markers for when it is no longer appropriate to be a state-chartered bank.
“The more we learn, the more I am certain that there are no easy answers or convenient explanations,” Grayson said, adding new reports on the situation will arrive in May.
What happens next will also depend on what the Biden administration discovers in its investigation. Federal law requires that large banks hold more investment capital than deposits so they can cover expenses and payouts in extreme circumstances. One of the ways banks can make investments is through Treasury bonds, which are government backed and considered low risk. Banks loaded up on the bonds at the start of the Covid-19 pandemic, when the Federal Reserve dropped interest rates to near zero.
Beginning in March 2022, however, the Federal Reserve has been consistently raising interest rates from a range of 0.25% to 0.5% to 4.5% to 4.75% at the end of January. This caused the price of T-bills to sink because investors were no longer interested in their low yields.
Because the FDIC insures only up to $250,000 in deposits per account, much of Silicon Valley Bank’s deposits weren’t covered by the government. According to a White House fact sheet, the FDIC only has clawback authority for the largest financial institutions.
Biden wants to give the FDIC the power to take back gains from stock sales by failed bank executives. Over the past two years, Silicon Valley Bank CEO Greg Becker reportedly sold nearly $30 million of stock, including $3.6 million in shares days before the bank started to collapse.