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The Collapse of Silicon Valley Bank: An Interview with Professor Bradford Gibbs

Image via Brown University

Bradford Gibbs is the Urry and Comfort Family Lecturer in Economics at Brown University. His focus is applied finance, and he teaches courses including Corporate Finance and Financial Institutions. Before his time at Brown, Gibbs co-founded a Sub-Saharan African banking group and later took it public on the London Stock Exchange. Gibbs also worked as a Managing Director at Morgan Stanley for thirteen years in Mergers and Acquisitions and Capital Market Transactions. Gibbs obtained his Master of Arts in Teaching from Brown in 2016, an MBA from the Wharton School of the University of Pennsylvania in 1998, and a Bachelors of Arts in history from Brown in 1993. 

Sophie Jaeger: Can you briefly explain the Silicon Valley Bank and Signature Bank collapses and what led up to them? 

Bradford Gibbs: Silicon Valley Bank was, up until recently, the 16th- or 17th-largest bank in the US, as you probably know: a $200 billion balance sheet, and that’s the total assets. Their business was really concentrated on the West Coast, although they did have an East Coast presence. They focused on really servicing the venture capital community, the startup community, and creating a very effective ecosystem in that they would offer you a loan. But in connection with that loan, they also wanted to make sure that you did all of your banking business at SVB, so they’d also want your deposits and your transactional banking. Once you were part of the SVB community, they could introduce you to other clients who were the CEOs of startups or venture fund managers and created a certain aura associated with doing business with SVB. They experienced really rapid growth. This bank was only founded in 1983.

They had what seemed like a pretty straightforward business model. They took deposits and they made loans, but, more frequently, they took those deposits and they invested in long-term treasury bonds, mortgage-backed securities issued by government-related entities, Fannie Mae, et cetera. Things that have near zero probability of default, but even though they don’t have default risk, they’re still sensitive to changes in interest rates. So they had this portfolio of bonds, and let’s just call it around $90 billion worth, that had what’s called a long duration. They weighted average cash flows for over about six years plus. Because of the Fed’s efforts to cut out inflation, interest rates have gone up by 450 basis points in the past 18 months.

As interest rates went up, the value of the bond portfolio went down. So, concerns spread, and those concerns led to depositors withdrawing their funds. When depositors withdraw their funds, the bank needs to give them their money back, so they need to start selling the securities portfolio. When they sold a part of the securities portfolio, they crystallized the loss on those bonds because the value of the bonds had declined in the context of the rising interest rate environment. Then, once they announced that they had a $1.8 billion loss on their available for-sale securities portfolio, and that they needed to raise additional equity capital, the market just went nuts. They effectively lost the confidence of depositors who recognized the fact that SVB only had 7 percent of its deposits insured, while 93 percent were uninsured (i.e. above $250,000). 

Then it became a classic run. Everyone wants their money back such that they’re not the last person in line who when they go to the teller window, the bank says, “Sorry, there’s no more money.” It’s pretty typical that a liquidity crisis like a bank run will lead to a solvency crisis, and that’s what happened with SVB.

SJ: How do you think these collapses will impact the Federal Reserve’s future decisions regarding additional interest rate hikes? 

BG: The collapse of these institutions and the stress that we’re seeing on some of these other regional banks like PacWest and First Republic is in and of itself a form of tightening of monetary conditions. As a result of concerns around the creditworthiness of other banks, banks aren’t lending to banks and then people aren’t making loans, and it’s really commensurate with raising interest rates. The Fed originally had been on track for a 50 basis point increase in light of the most recent inflation data but decided to throttle back because there was a high probability in the Fed Funds Futures market that there may be no increase. Similarly, there was a view (and I shared that view) that the Fed wanted to signal its continued intent to combat inflation, stuck to its guns, and compromised with the 25 basis point increase, recognizing that frankly, the tightness created by SVB and Signature probably implied an additional at least 25 basis point increase above what they actually communicated.

SJ: Do you think the Federal Reserve’s policies during the coronavirus pandemic had an impact on the collapses? 

BG: I don’t think the coronavirus pandemic-related response necessarily did. Obviously, the pandemic led to an extended period of really dovish monetary policy with near-zero interest rates, which very much supported SVB strategy of borrowing short and investing long, but I don’t think that in and of itself contributed to where we find ourselves today. I think what contributed to where we find ourselves today is that SVB had really been reluctant to hedge itself against interest rate increases as a result of the impact of the hedging on its quarterly earnings. Thus, they took a calculated gamble that interest rates might increase, but it wouldn’t impact their deposits. They would never be forced to monetize the loss embedded in their treasury positions. That ended up not being the case. 

Then, there’s a lot of hand-wringing right now about the fact that there had been a rollback of the regulations related to the supervision of mid-size banks SVB had been lobbying for. You have senators like Senator Warren looking to reevaluate the additional requirements of that kind of mid-tier, below the mega banks (JPMorgan, Bank of America, Citi, and Wells Fargo). Even if SVB had been subject to the more intense stress tests that the large banks had been subject to, the parameters of those stress tests did not incorporate a 400-plus basis point increase in rates. So would we necessarily have had the red flags a couple of years ago? No. Does it sound like there may have been red flags over the past 12 to 18 months? Yes. Where I think we will probably have more discussion is whether or not this is going to be an impetus for the raising of the Federal Deposit Insurance Corporation (FDIC) deposit insurance levels. The last time we raised it was 2008. Before then, it hadn’t been raised since 1980, so it’s probably due for another increase.

SJ: In the case of SVB and Signature Bank, the FDIC stepped in to secure investors’ deposits. Do you think this move was effective in quelling concerns about the banking sector?

BG: Yes. If they didn’t exercise this kind of exceptional extension of ensuring previously uninsured deposits, I think that you would have seen an even larger acceleration of deposits being transitioned from smaller regional banks to mega banks. That’s not good for the system. There are some people who don’t believe that but will never have the counterfactual to know how bad it would have been if that hadn’t been the case. I think everyone would like to be a libertarian, but they may not like what that ultimately leads to.

SJ: Can you explain why the collapses of SVB and Signature Bank have had such a ripple effect on the global market, especially in the case of Credit Suisse? 

SJ: I’ll talk about the North American banking market. When people saw the collapse of SVB and Signature, there was a recognition that these weren’t the only institutions to have been beneficiaries of significant inflows of low cost deposits and have large portfolios of fixed rate assets that are underwater as a result of the interest rate increases. There are around $650 billion of losses sitting on banks balance sheets. Now, those don’t have to be crystallized because those are mainly securities that they intend to hold to maturity. So, they won’t sell them at a loss and thus they don’t show that loss, but hypothetically, that loss exists. So, the recognition of the significant interest rate exposure of the global financial sector led to this consternation and thus you saw wholesale declines across the S&P financials. Then, there’s a regional bank index—the Keefe, Bruyette, Wood Index— and some broker dealers like Charles Schwab that all saw meaningful declines. Credit Suisse is a slightly different animal.

Credit Suisse has been suffering from a whole host of incidents that go back at least 10 years and it’s just been one thing after another, which has undermined confidence in the institution. The wobble in the markets more broadly was simply the final straw that drove Credit Suisse into the arms of UBS. 

SJ: What impacts have these collapses had on smaller businesses and other mid-size banks? 

BG: Well, I think you’re seeing continued deposit outflows. Some institutions are reporting a stabilization of deposits, but you are seeing a huge inflow–and a historically high inflow–into money market mutual funds. Why? Well, money market mutual funds invest in short-term treasury bills and given that up until recently the 6-month T-Bill was yielding 5 percent, that’s a pretty attractive place to park your money on a “risk-free” marks basis. If they have more than $250,000 at a bank and they’re earning a fraction of that and it’s uninsured, then maybe they should rethink their funding strategy. So, I am concerned that we’re going to continue to see outflows from smaller banks, and you’re going to see clients really focused on bank diversification. 

No one can afford to have money at a bank that they intend to use for payroll and then have that bank collapse because then what are you going to do with your employees? You need to cut them paychecks on the Tuesday of that week, the bank’s been taken over by the FDIC. Your deposits of over $250,000 are not null and void, but you’re going to have to wait. 

SJ: How big are the regional banks as a percentage of the overall US banking system? 

BG: Small banks are really important. New banks below the Big Four and one with assets less than $250 billion represent about 50 percent of lending when it comes to consumer lending and corporate lending and an even larger percent when it comes to real estate-based lending. There needs to be a lot of thoughtful conversation among policymakers about how we ensure their continued success.

SJ: How do the impacts we’ve seen on regional banks impact banking goliaths like JPMorgan or Bank of America? 

BG: The Big Four have been wholesale beneficiaries of the recent events. Bank of America during the course of last week had an influx of more than $8 billion of deposits, and JPMorgan led a group of banks to effectively recycle the deposits that they’ve received as a result of the collapse of SVB back into the regional banks by way of this infusion into First Republic. While an unstable banking environment hurts everyone on a relative basis, they’re coming out, if not marginally unscathed, perhaps even a bit stronger. But they want to ensure a healthy banking system at large, so I don’t think there’s any banking executive at those major firms doing high fives.

SJ: Do you think that it’s possible that these collapses could lead to a recession? 

BG: Recession risk has been out there for some time. Is it possible that they will increase the probability of recession? The answer is yes. What you’re going to see is the result of the combination of the continued interest rate increases and a breakdown in trust in the financial system: a throttling back of credit originations, of people making loans. Banks are in the business of asset transformation, taking your deposit, and using it as a loan to fund the construction of a new building or the extension of a factor. As a result, it is going to further pump the brakes on the economy. However, employment numbers remain at historic highs, unemployment at historic lows, and economic activity hasn’t been terrible with China relaxing Covid-19 restrictions, so we’ve seen a wholesale pickup in the global industrial economy. The decline in oil surprises me; it seems to indicate activity isn’t as robust as we thought. There is a lot of data, which is giving contrary indications of where we are headed. The Fed Funds dot plot, which shows the members of the FOMC committee’s expectations of where interest rates are gonna go, shows interest rates declining into the second half of this year, indicating that the Fed may have to start easing rates to stimulate economic activity. 

SJ: What lessons can we learn from this event and how can we prevent it from happening again in the future? 

BG: It seems like we continue to play whack-a-mole in that after the global financial crisis, we were very focused on reigning in the shadow banking system, getting rid of things like, ninja loans, no income, no job mortgages. We were very focused on defining a group of systemically important financial institutions called SIFIs and G-SIFIs, Globally Systemically Important Financial Institutions. We created additional constructs in terms of stress testing and regulatory requirements. We solved one problem then we turned around and there’s another problem, which is that there are a bunch of banks that haven’t had risk management policies in place to hedge themselves from interest rate risk. It’s kind of a bread and butter issue. So what are we going to see? We’re going to see regulation to the extent that people have larger proportions of uninsured deposits, they need to have more capital, and we’re gonna see more robust stress testing. We’re going to see that regulatory framework for the SIFIs applied to a broader swath of the banking sector.

This interview has been edited for length and clarity.