OPINION:
The Silicon Valley Bank collapse has provoked the usual caterwauling about bank regulation. But tougher rules could do more harm than good and likely won’t avert the next crisis.
The White House wants to reimpose some of the stricter Dodd-Frank rules on midsize banks that were rolled back by Congress during the Trump administration. Federal agencies appear inclined to impose new liquidity requirements and reexamine capital standards.
Essentially, people and businesses put money in banks for safekeeping and to enable transactions. To offer these services, banks charge fees and invest most of the funds.
At one time, banks imposed monthly account charges and check writing fees, but those were unpopular and driven out by competition for depositors among banks. Banks mostly rely on interest income from consumer and business loans, residential and commercial mortgages, Treasury and federally backed mortgage securities, and some other safe fixed income instruments.
Except for near dated bonds and loans, those assets are often illiquid and hard to value, and their market prices can abruptly change. For example, as interest rates rise, the market value of existing bonds falls.
Banks minimize the impact of these factors on their balance sheets through convenient accounting rules.
Generally, banks recognize bonds at their redemption or face value even when interest rates rise. That’s reasonable if bonds are held to maturity and the banks have a liquidity problem, not an insolvency issue.
No bank is safe if depositors believe a bank is insolvent and withdraw their funds en masse — something that can happen with lightning speed thanks to social media and online banking.
Dodd-Frank encourages all banks to apply more careful lending standards, and banks have increased their reliance on safe government securities for income.
As a share of assets, banks increased their holdings of Treasuries and federally backed mortgage bonds from 12% from before Dodd-Frank to 20% in 2022. SVB and many other banks went further, and as the Federal Reserve pushed up interest rates, those took large losses on the market value of those securities.
At the end of 2022, SVB had assets of $212 billion and from January to early March depositors withdrew $68 billion — $42 billion on its final day of operation. Holding enough reserves and very short dated safe securities to handle that kind of run and what may have followed had the Federal Deposit Insurance Corp. not seized control would have made it unprofitable or at least not profitable enough to justify staying in business.
The problem is endemic. Researchers at Stanford University estimate that as a share of assets, 11% of all U.S. banks took larger paper losses than SVB as interest rates rose.
Regulators cannot possibly set liquidity requirements high enough for that without rendering small and medium-sized banks unprofitable. Their idle reserves and very short dated safe bonds would pay too little, unless the banks charged a lot more for loans.
Higher rates for bank loans would push deposits and loans outside the regulated banking system to money market funds, commercial credit brokers, fintech and private equity, where ordinary consumers and businesses enjoy less safety and loans offer weaker protections or tougher terms for borrowers.
Higher capital requirements would reduce the losses the FDIC endures when banks fail, but those would similarly reduce bank profitability and driving deposits and lending outside the regulated banking sector.
To address the liquidity problem, Congress should make permanent the temporary facility the Fed created in the wake of the SVB collapse that lends to banks against Treasuries, federally sponsored mortgage securities and safer assets.
Had SVB and other banks had that option as interest rates rose in 2022, liquidity squeezes and solvency fears would not have occurred.
Limiting deposit insurance to $250,000 per account is silly in an era when money is mostly electronic — currency and coins constitute only about 10% of the global money supply. It’s unrealistic and counterproductive to expect individual depositors to have the technical expertise or time to evaluate the liquidity and solvency of banks.
Insuring virtually all deposits would require raising the basic FDIC assessment on deposits from 0.05% to 0.1% and should be manageable for even the smallest banks. Liquidity and depositors’ nerves won’t be central to the next likely challenge facing banks and federal regulators.
Work from home has substantially decreased the demand for office space in major cities. As leases expire, tenants are purchasing less space and landlords have begun missing mortgage payments. Exacerbating this, commercial construction and renovations have long lead times, and projects initiated before the pandemic are increasing inventories.
Small and medium-sized banks account for 38% of outstanding loans, and commercial property accounts for 67% of their portfolios.
A wave of defaults could precipitate a recession no matter what the Fed does. That was not much mentioned at the recent congressional hearings focusing on SVB and bank regulation.
• Peter Morici is an economist and emeritus business professor at the University of Maryland, and a national columnist.
Please read our comment policy before commenting.