Key Takeaways
- • Elham Saeidinezhad argues that Silicon Valley Bank's collapse on March 10, 2023 reflects two structural shifts: depositors have become informed rather than uninformed, and regional banks have adopted hedge-fund-like asset strategies.
- • The author contends that informed depositors "mark to market" bank balance sheets and run on institutions that lack interest rate hedges, as SVB did at the end of 2022.
- • SVB reported virtually no interest rate hedges on its massive bond portfolio at year-end 2022 and terminated or let expire rate hedges on more than $14 billion of securities during the year, per the article.
- • The article describes regional banks' involvement in fund subscription lines, which turned them into private equity-style investors rather than traditional creditors.
- • The author proposes that interest rate swaps and private derivative-based risk management can address the interest rate exposure that the current regional banking structure creates.
Summary
Silicon Valley Bank's failure on March 10, 2023, according to the article, marks a turning point in modern banking. Elham Saeidinezhad, writing on Phenomenal World, identifies two shifts exemplified by the bank's collapse: a liability-side change in depositor sophistication, and an asset-side change in which regional banks took on risks similar to those of hedge funds engaged in fixed-income arbitrage.
The article contrasts the classic Diamond-Dybvig model, which assumes uninformed depositors who run on banks driven by "animal spirits" and are stabilized by deposit insurance, with recent events. The author argues that depositors at SVB, Signature, Silvergate and other regional banks were informed. They scrutinized financial statements, marked the bank's assets to market, and identified its exposure to interest rate risk. The absence of interest rate hedges on SVB's bond portfolio triggered the run. The author argues that the US government's unlimited deposit insurance offer has not calmed markets because it presumes the uninformed behavior the Diamond-Dybvig model describes.
Saeidinezhad traces this change to the 1950s, when institutional investors such as pension funds replaced retail depositors, and to post-2008 liquidity rules such as the liquidity coverage ratio. Those rules pushed large institutions including JPMorgan Chase, Credit Suisse and Bank of America toward market-making, leaving medium-sized and regional banks to expand deposit-taking and other activities. Those banks, the article says, turned to fund subscription lines, loans to venture capital and private equity managers secured against uncalled capital commitments, through which banks anticipated capital gains rather than interest income. The author describes SVB's shift away from traditional lending toward long-duration government bonds as a consequence of its specialized client base of startups and crypto investors, who relied on equity rather than loans.
The article illustrates the interest rate risk with a stylized example in which a $100 bond falls to $97 when rates rise, leaving the bank insolvent on a marked-to-market basis. The author proposes interest rate swaps as a hedging tool and gives an illustration in which a $100 million bond portfolio yielding 3.2 percent could be swapped into floating rate plus 10 basis points through a dealer such as Citigroup. The article concludes that a private risk-management solution available through derivative markets may suit the current regional banking structure better than existing deposit insurance alone. The piece also draws a parallel to the 1998 collapse of Long Term Capital Management, which relied on fixed-income arbitrage, as a blueprint for understanding regional banks' asset-liability management.
The article contrasts the classic Diamond-Dybvig model, which assumes uninformed depositors who run on banks driven by "animal spirits" and are stabilized by deposit insurance, with recent events. The author argues that depositors at SVB, Signature, Silvergate and other regional banks were informed. They scrutinized financial statements, marked the bank's assets to market, and identified its exposure to interest rate risk. The absence of interest rate hedges on SVB's bond portfolio triggered the run. The author argues that the US government's unlimited deposit insurance offer has not calmed markets because it presumes the uninformed behavior the Diamond-Dybvig model describes.
Saeidinezhad traces this change to the 1950s, when institutional investors such as pension funds replaced retail depositors, and to post-2008 liquidity rules such as the liquidity coverage ratio. Those rules pushed large institutions including JPMorgan Chase, Credit Suisse and Bank of America toward market-making, leaving medium-sized and regional banks to expand deposit-taking and other activities. Those banks, the article says, turned to fund subscription lines, loans to venture capital and private equity managers secured against uncalled capital commitments, through which banks anticipated capital gains rather than interest income. The author describes SVB's shift away from traditional lending toward long-duration government bonds as a consequence of its specialized client base of startups and crypto investors, who relied on equity rather than loans.
The article illustrates the interest rate risk with a stylized example in which a $100 bond falls to $97 when rates rise, leaving the bank insolvent on a marked-to-market basis. The author proposes interest rate swaps as a hedging tool and gives an illustration in which a $100 million bond portfolio yielding 3.2 percent could be swapped into floating rate plus 10 basis points through a dealer such as Citigroup. The article concludes that a private risk-management solution available through derivative markets may suit the current regional banking structure better than existing deposit insurance alone. The piece also draws a parallel to the 1998 collapse of Long Term Capital Management, which relied on fixed-income arbitrage, as a blueprint for understanding regional banks' asset-liability management.
Go deeper than the headline
Research every firm in this story, track the ones that matter and get the daily briefing — free for 7 days.