SVB proves even smaller banks are too big to fail

LONDON, March 15 (Reuters Breakingviews) - The too-big-to-fail problem is proving hard to pin down. On Thursday it will be 15 years since Bear Stearns, an investment bank with assets of $400 billion, was rescued from collapse by JPMorgan (JPM.N). The financial crisis which brought about its downfall triggered a years-long global push by regulators to make sure even the biggest lenders could be safely wound down. Yet last weekend U.S. authorities struggled to contain the fallout from the collapse of SVB Financial (SIVB.O), a relatively simple institution about half the size of the defunct Wall Street firm. The threshold for “too big” is smaller than many thought.

Multiple mistakes contributed to the demise of America’s 16th-largest lender. The institution known as Silicon Valley Bank drew most of its clients from the tight-knit community of venture capital firms and startups which congregate around San Francisco. More than 90% of its deposits were above the $250,000 threshold guaranteed by the Federal Deposit Insurance Corporation, making them vulnerable in a panic. The bank assembled a $91 billion portfolio of long-dated securities which tumbled in value when interest rates rose, producing losses which, if realised, would have wiped out its capital. SVB then launched a half-baked $2 billion equity offering which did little but signal the depth of its distress.

None of these problems should have posed a threat to the U.S. financial system. After 2008, global regulators designed elaborate rules to make banks safer, and to limit the economic impact if they failed. In particular, financial institutions had to issue debt which could be written off in a crisis. Combined with common equity this forms a buffer, known as Total Loss-Absorbing Capacity (TLAC), to protect creditors – and particularly depositors – from even large losses.

Yet U.S. regulators applied these provisions only to the country’s largest banks. Mid-sized and regional lenders successfully lobbied to be exempted from them. Bankers argued that issuing extra bonds imposed unnecessary costs on lenders which rely mostly on deposit funding. SVB Chief Executive Greg Becker was an enthusiastic advocate for a lighter touch. “SVB, like our mid-sized market peers, does not pose systemic risks,” he told Congress in 2015.

The result was that when SVB failed, it had no additional buffer, leaving uninsured depositors potentially on the hook for losses that exceeded its capital. Contrast that with the bank’s tiny British subsidiary, which had assets of just 8.8 billion pounds ($11 billion). The UK unit had about 350 million pounds of additional capital which was written down to zero, helping facilitate its sale to HSBC (HSBA.L), (0005.HK) for 1 pound.

SVB’s collapse highlights another flaw in the traditional playbook for rescuing banks: a shortage of buyers. In the past, authorities dealing with a failing lender often helped arrange a sale to a bigger and healthier rival, as they did with Bear Stearns. That became harder after 2008, as regulators discouraged the biggest banks from getting larger. Five days after SVB failed, no buyer has yet come forward. It doesn’t help that U.S. watchdogs have previously made it clear that bank consolidation faces a high bar: US Bancorp’s (USB.N) purchase of MUFG Union Bank, announced in 2021, took a year to get approval.

The result is that, once again, the American government has come to the rescue. On Sunday authorities including Treasury Secretary Janet Yellen guaranteed all the deposits of SVB and another failed lender, while the Federal Reserve opened a generous liquidity facility which allows banks to exchange government bonds for cash above the market price. Granted, regulators did not inject capital directly into banks, as they did in 2008. However, the implied message that all bank deposits are safe represents a huge potential liability for the U.S. government.

It’s tempting to write off the SVB debacle as a specifically American failure. That would be a mistake. Not many banks in the developed world have failed in the past decade, giving regulators few opportunities to try out their too-big-to-fail tools. That’s partly because banks are safer. But it’s also because ultra-low interest rates long shielded lenders from the consequences of bad loans and investments.

In the United States, regulators are already sharpening their pencils. The Fed and the Office of the Comptroller of the Currency last year mooted the idea of extending rules for giant banks to large regional lenders. As recently as October, Fed staff flagged that these banks were becoming increasingly dependent on uninsured deposits.

Fifteen years ago, regulators and politicians across the developed world vowed that taxpayers should never again be on the hook for banks’ mistakes. The SVB fiasco shows that promise remains unfulfilled. It’s a timely reminder that even smaller banks can be too big to fail.

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(The author is a Reuters Breakingviews columnist. The opinions expressed are his own.)

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