Structural Flaws and Bank Contagion

The Federal Reserve published an ironic report on the day that the FDIC took control over the First republic Bank. The report was all about the demise of Silicon Valley Bank. It was a retrospective of sorts on what contributed to the failure of the bank and what shortcomings were present at the bank regulator. 

The thesis of the report is that the issues of SVB were unique to SVB. But that fails to address why there was a similar problem at Signature Bank. Or what about the problems at Credit Suisse, or First Republic Bank? 

Under the Dodd Frank Act which was passed in the wake of the GFC the FDIC is supposed to hold 1.3% of all insured deposits in reserve. Well, it’s clear that the FDIC has nowhere near that amount being held in reserve. 

The FDIC balance sheet was consumed by 50% on the SVB transaction. There can’t be much left. 

So here we are, six weeks after the first bank failure.  In the immediate aftermath we were told that the cause was weak management and that the banking system is resilient and strong. Then we heard the same message when Signature Bank failed. Now First Republic, but the banking system is resilient and strong. 

The fundamental problem is that there is a mismatch between the nature of the actual liquidity of the banks and the structural liquidity of the banks. What I mean is that depositors can request their money on any given day. But when the bank lends money, they lend it for long duration. So the banks’ true ability to generate liquidity is far less than the expectation of giving depositors their funds on demand. 

We learned that lesson when Lehman Brothers failed in 2008. Lehman Brothers bank in the Bahamas was taking in LIBOR deposits which were of short duration. When deposits dried up, the bank became insolvent overnight. 

Yes, Lehman Brothers was structurally flawed that is clear. But what about any bank? Are they truly in better shape?

We have banking contagion. It is here. It was easily predictable, and our banking system is not resilient nor is it strong. 

There are calls from the white house for increased banking regulation. But if you actually take time to read the SVB report, it is clear that the existing regulations were not actually being used. 

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Host: Victor Menasce

email: podcast@victorjm.com