SVB’s Failure – Things are Impossible Until They are Inevitable

SAN FRANCISCO, CA, March 15, 2023. Silicon Valley Bank (SVB) was closed by Regulators on Friday, March 10, 2023. Few would have predicted the sudden demise of Silicon Valley Bank. For 40 years it had been a crucial financial intermediary for VC investments in start-up companies in California and throughout the world.

SVB wasn’t large by many metrics. It wasn’t a systemically significant bank (SSB). Federal regulators had never characterized the Bank as so systemically important that its failure would cause significant disruption to the financial system due to its size, complexity, and systemic interconnectedness. Well, that was before the FDIC, OCC, and Treasury Department decided on Sunday, March 12th that perhaps SVB was an SSB and agreed to make whole all depositors who still had “uninsured deposits” at SVB.

At the end of the day, money is inventory for banks. SVB had too much inventory. Too much inventory would normally be a bad decision for any business and, in this case, deadly for SVB (along with the widely reported serious long-short maturity mismatch).

One way of viewing the problem is that SVB was smaller than the systemically significant threshold but was in fact systemically significant because it was crucial to a critical market sector – tech and VC firms. Had it been an SSB, it would have been subject to the Liquidity Coverage Ratio (LCR) rules, and to greater scrutiny by federal regulators (and probably would have had more experienced resident examiners crawling over it). What if an even smaller bank was critical to a specific geographic or product market? Do you just let that market suffer if that bank is not well managed and fails?

And what are the implications of the asset management and shadow banking industry having such concentrated power over the liquidity of a bank – or maybe, now, the entire banking sector? Once upon a time, the FDIC wanted depositors to monitor the condition of their bank so that they did not rely entirely on deposit insurance. Now, the brokered deposit rules imply the exact opposite. Prior to SVB’s failure, some observers could have argued that the real definition of a supposedly “good” retail deposit is a deposit held by a person less sophisticated or not inclined to do anything but keep their deposits under the insured deposit limit and to ride with the bank right off the cliff.

Maybe the FDIC will adopt rules that are the equivalent of casinos’ ban on card counters – protect banks from depositors that are sophisticated enough to protect themselves (elements of the brokered deposit rule sort of do that). In real-time last week, we witnessed how social media and powerful apps on mobile phones, which permit near real-time movement of funds, appeared to trigger the massive, single-day, $42 billion bank run that brought down Silicon Valley Bank. There will certainly be more to this story including that the DOJ has commenced a criminal investigation (as reported by the Washington Post).

The policy implications of SVB are significant. SVB’s failure will likely prove the adage that things are impossible until they are inevitable. Stay tuned…

Joseph, Cohen & Del Vecchio’s banking industry and financial services practice is comprised of some of the most experienced banking and regulatory lawyers in the nation.

*Jonathan D. Joseph is a shareholder and Michael Kadish is Of Counsel at Joseph, Cohen & Del Vecchio, PC.