Bailout or not?

Ad hoc steps to stop banking contagion may have implications

The fall of Silicon Valley Bank (SVB) has had effects around the world. Its affiliate in the UK has been acquired by HSBC; Japan’s SoftBank Vision Fund, already under pressure, will see more of its investments sour; Sweden’s pension fund lost over a billion dollars. But the immediate risk of a major financial crisis and broader bank contagion seems to have been contained, thanks to swift action over the weekend by market regulators in the US. It was announced on Sunday that, while equity holders in the bank would be wiped out, the federal government would ensure that no depositors, even those above the mandated deposit insurance level, would lose money. The costs of this action, however, should now be analysed, and lessons from SVB’s failures examined.
 

US Treasury Secretary Janet Yellen, mindful of the political costs of rescuing SVB’s customer base — who, being largely from the well-funded tech and start-up industry, are not popular with voters — has insisted this is not a bailout, and that no taxpayer funds will be used. This is technically accurate in that the bank and management are not being rescued. But in the broader sense, a new tax is being levied on the banking system to provide guarantees to depositors who were previously unguaranteed. So, as with bailouts, the general public — which will have to pay a higher cost for banking services —is on the hook. And there is also a moral hazard problem that has been created. It is clear that SVB was poorly managed: It did not invest enough in hedging against price falls in the long-duration bonds it held, it did not take into account how its depositors were concentrated in a single industry and so might need money all together in the case of a sectoral downturn, and it had overly bright estimates of borrowing growth.
 

The new measures taken by US regulators also need to be examined carefully. In 2018, SVB and other small banks were provided with exemptions from post-crisis banking regulations. But the US Federal Reserve and the Treasury Department have not restored the status quo ante. Instead they have addressed the immediate problem of interest-rate risk in an environment of rising rates. A new facility that will lend against collateral valued at par has been introduced, removing the risk to banks from held-to-maturity paper that suddenly has to be marked to market. Is it a good idea to remove interest-rate risk from the equation for banks? And should all depositors indeed be made secure by regulation? Will banks compete on better practices then? These questions are important to ask because the world is, for the first time, facing sharply rising rates in the age of social media.
 

As with SVB, the ability of rumours to go viral in minutes means that bank runs have become more possible. Given the risk to banks’ treasuries from sharply higher rates, new regulations for this new era might become necessary. But whether the mix of actions improvised over the weekend can be replicated elsewhere or made permanent is far from clear. More work will be needed by banking regulators, including in India, before the global financial system can be said to be insulated from the risks.