President Joe Biden recently announced that new banking regulations are coming.  Surprise, surprise.  Much has been written about what caused Silicon Valley Bank and Signature Bank to fail, but few have put forward solutions on how to prevent it from happening again.  People are too caught up in political narratives and arguing whether or not it was a “bailout.”

What could the Biden administration have in mind?  Especially with a Republican-led Congress.  The same party whose President signed into law reforms to Dodd-Frank that exempted banks like SVB and Signature from key requirements: stress tests, living wills, capital requirements, and more.

Below are three ways the government can address the recent bank failures (video version here). They are based on the key risks from my perspective, which is informed by almost a decade of experience working as a compliance officer on Wall Street.

1. More transparency for “Held-To-Maturity Assets”

Do you know what was on SVB’s balance sheet?  They had huge positions in long-dated government bonds.  Normally, you might think, “Okay, that’s pretty safe.  Backed by the full faith and credit of the federal government, what could go wrong?”

Interest rates.  But before we get there, consider why SVB had those assets on its books in the first place.  There were two primary reasons:

• The majority of its customers did not need business loans – as a financial institution that primarily banked startups, small tech businesses, and other entrepreneurs, most of the client base was already awash in venture capital funding.  Most of these clients didn’t need SVB’s money.  Venture capitalists were basically throwing money at founders and startups in 2021 and in the years prior.  I even noted in this article on Elizabeth Holmes about how her guilt was not going to slow down the gravy train.  So if a bank is getting deposits and has no client demand for lending, what does it do?  It might buy long-dated assets and take a spread.   
• Held-To-Maturity.  Most of the bonds purchased by SVB were categorized as “Held-To-Maturity Assets.”  For accounting purposes, these are not required to be mark-to-marketed every day.  That basically means for reporting purposes to the investing public, SVB didn’t have to show these assets as a realized gain or loss until they either sold them or they matured.  Regardless of their price fluctuation in the interim.  If they were big losers, they could hide in plain sight on the balance sheet.  That only becomes a big problem when they have to be sold, of course, and unfortunately for SVB that day of reckoning came when more and more of their tech clients pulled deposits as they burned through cash (the tech industry was slowing down and venture funding was drying up as rates were rising).

Enter the interest rate hikes of the Federal Reserve.  The rising interest rates not only cooled the tech industry’s salivary glands for venture funding, it caused startups to burn through cash like never before.  As more clients pulled money from SVB, the bank had to cover those liabilities.  They had to sell assets.  Yes, those long-dated bonds.  At big losses.

As interest rates go up, bond prices go down.  Think about it.  If you bought a 30-year U.S. Treasury at 4%, and rates hypothetically increased by 1%, nobody will want your long-dated treasury if they could just buy the latest one.

In its most simplified form, that’s what happened to SVB.  The BIG problem, however, was that those assets were originally intended to be “held-to-maturity.”  Until they weren’t.  Until they were needed to pay back customers who were pulling deposits.

The investing public needs far more transparency on any asset designated as “held-to-maturity.”  These assets should not be able to hide on balance sheets with no daily, weekly, or even monthly mark-to-market.  How can an investor adequately judge a public company if they don’t understand the full value of these assets, especially with an active Federal Reserve?  We certainly can’t expect depositors to appreciate these risks.

Move number one by the Biden Administration should be to bring more transparency to held-to-maturity assets.  Require more frequent marking of these positions.  Pull back the opaque curtain.

2. Reinstate key Dodd-Frank provisions for small and mid-sized banks

Another curtain that requires pulling back is the one that now shields many small and mid-sized banks from more intensive regulatory scrutiny.  As mentioned in the introduction, the Trump administration signed a bipartisan bill to roll back certain key provisions of Dodd-Frank that applied to small and regional banks.  In particular, they raised the applicability threshold for these requirements from $50 billion to $250 billion in assets.

Guess which banks had assets under the $250 billion threshold, but above the old $50 billion threshold?

You got it: Silicon Valley Bank and Signature Bank.  

The latter had started banking crypto companies, albeit in much smaller sizes than its other failed peer, Silvergate.  But still.  Because it was exempt from much of Dodd-Frank, Signature Bank was not subject to stress tests, living wills, and other capital requirements.  Federal regulators weren’t constantly knocking on Signature’s door since 2018.

You would think that a bank that discovered a newfound love for crypto would be of interest to federal regulators.  I can tell you from firsthand experience that most of the big banks – like the one I worked at – wouldn’t even touch the physical digital assets.  They might trade the futures or other derivative contracts, but getting intimately involved with the actual tokens, crypto, or companies who engage in that as their primary business was a big no-no.  Remember what Jamie Dimon infamously said?

It wasn’t even so much that big banks didn’t have the interest or appetite for it, but that big banking regulators like the OCC didn’t want to permit big banks to trade in virtual currency.  Signature Bank had no such oversight, especially following the 2018 rollback of Dodd-Frank.

Although crypto made up only a small portion (~15%) of its balance sheet, Signature was known as the other crypto bank.  Once Silvergate met its demise and SVB shuttered, there was no confidence left for Signature.  I cannot help but think what a few stress tests could have revealed.  Or what stricter capital requirements could have done.

Prevent this from happening again by reinstating the $50 billion threshold for those requirements.  All banks with that many assets (or more) should be subject to stricter scrutiny.  As we’ve seen, even at the sizes of Signature and SVB, they can pose systemic risk to the financial system. 

3. Establish FDIC threshold for small businesses  

Why do individuals get depository insurance up to $250,000, but businesses don’t?  I know, businesses are in the game of risk taking, but shouldn’t their deposits (up to a certain point) be treated similar to individuals in the event of a bank failure?

It might make sense for that threshold to even be a little higher, say a few million or so.  I’m not sure on the exact number, but after witnessing what one industry basically did to SVB by instigating its own bank run, I’m more convinced than ever that we need a FDIC threshold for small businesses.  

The close-knit Silicon Valley community all talked.  They all decided that SVB was in trouble.  They created their own panic.  They experienced a collective loss of confidence.

What would have happened if their companies had guarantees that at least a few million of their deposits were safe?  Would they have wired out all of their money still?  I don’t think so.

In fact, I think a small threshold for guaranteeing small business deposits would have given SVB the lifeline it needed.  This bank was not in the midst of a credit crisis.  It was a perfectly solid business that made some poor risk management decisions in a rising interest rate environment.  But they still could have weathered the storm if their customers had not turned against them. 

The customer-induced liquidity crisis became a self-fulfilling prophecy.  But had more of those customers had some government guarantees, it might not have happened.  They might have had just enough confidence in the system to allow SVB and even Signature to see another day.

What do you think?  

Those are my top three reforms following the SVB and Signature collapses.  Unlike some, I don’t think these bank failures are indicative of a broader crisis like what happened in 2008.  There was serious greed and fraud during the financial crisis.

Here, we had a serious case of mismanagement and a major loss in consumer and investor confidence.  Based on what we know now, at least.  Although there are some questionable trades by executives in the days and weeks prior to the SVB collapse. 

But I want to end this on a happy note.  I think these reforms will add the necessary safety and soundness to the banking system.  But I’m sure there are other great ideas that I’m missing.  Please enlighten me with yours.