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Silicon Valley Bank’s problems were visible without a stress test

The recent bank issues continue to create angst but there are some simple conclusions which should help frame your opinion of the discussion.

Some critics assert there is a link between the failures of Silicon Valley Bank (SVB) and Signature Bank of New York with bipartisan legislation passed in 2018 that rolled back some, but not all, of the onerous rules enacted as part of the DoddFrank Act for regional banks with equity between $50 billion and $250 billion. This action left full regulation in place only for large banks, often dubbed the “systemically important financial institutions.”

The most prominent of these rules was the requirement for annual “stress tests” conducted by the Federal Reserve Board. The current criticism claims that these stress tests could have revealed the problems at SVB. This assertion is too simplistic and not really correct.

The fundamental problems at SVB were readily visible and should have been uncovered by even a cursory bank examination or offsite supervisory analysis. The most prominent problem was management of interest-rate risk in SVB’s securities portfolio.

Incredibly, SVB released its director of risk management in April 2022 and did not replace the position. This was known to the regulators. Simple question: Who has responsibility for this task?

Banks must publicly document their equity position in a quarterly “Call Report,” which is a publicly available regulatory report filed quarterly with the U.S. FFIEC (Federal Financial Institutions Examination Council – a formal U.S. government interagency body composed of five banking regulators).

SVB showed the full final value at maturity of the U.S. Treasury bonds it owned, not the current value, which was lower. The lower value was what it would receive if it sold the bonds immediately. SVB did not deal with these lower values by “booking” them in the report at the lower value. It showed a higher value that was misleading.

Anyone could have downloaded these reports and seen the growing multi-billion losses in SVB’s securi- ties portfolio. By Q4 of 2022, these losses exceeded the bank’s equity capital, but losses evident as far back as 2022 Q1 indicated that the bank would have been undercapitalized if it had been required to recognize these unbooked losses. No detailed Fed stress test was required to reveal this basic failure of asset-liability management. Compounding the problem of unbooked losses on securities was SVB’s incredible reliance upon “uninsured deposits,” which are deposits above the $250,000 limit per account on FDIC deposit insurance. This point is fundamental because uninsured deposits are more likely to experience sudden withdrawal when rumors, or facts, circulate about a bank’s financial viability. No “stress tests” were required to uncover SVB’s reliance upon uninsured deposits. Like the unbooked securities losses, uninsured deposits also are reported on the Call Report by every bank with more than $1 billion in assets for this very reason.

At the end of 2021, SVB reported uninsured deposits of $166 billion (87%) out of total deposits of $191 billion.

Further compounding these two problems was the lack of diversification in SVB’s loan and deposit portfolios. SVB had built its franchise during the past decade by catering to the venture-capital community, VCs and the companies they fund.

Large depositors became worried and withdrew huge amounts to protect the uninsured amount of their deposit. SVB was forced to sell the bonds at lower prices to fulfill the withdrawals. They ran out of money.

In combination, these three problems spun out of control and the bank failed. No stress test was required to foresee this possibility. Where were the board of directors?

Where were the regulators? Do we really need more regulation or just a push to ensure that the regulators enforce the existing rules and regulations?

Mark Sievers, president of Epsilon Financial Group, is a certified financial planner with a master’s in business administration from the University of California, Berkeley. Contact him by email at mark@wealth matters.com.

Former Google CEO rejects AI research pause over China fears

Putting a temporary pause on artificial intelligence development would only hand an advantage to competitors in China, former Google CEO Eric Schmidt said, after more than 1,000 researchers signed a letter warning of the consequences of moving too quickly on AI research.

Speaking to the Australian Financial Review in an interview published Friday, Schmidt said there were legitimate concerns about the speed of research into AI but they should be mitigated by tech companies working together to set standards.

In the past week, more than 1,000 researchers and executives, including Tesla Chief Executive Officer Elon Musk, signed an open letter published by the Future of Life Institute, which called for an AI research pause of “at least six months,” warning of “potentially catastrophic effects” on society if appropriate governance wasn’t put in place.