Instability in our Banking System: Lessons From the Silicon Valley Bank Collapse

The failure of Silicon Valley Bank, holding predominantly uninsured customer accounts worth $175 million, serves as a stark reminder of the weaknesses present within the U.S. banking system. In contrast to infamous financial institutions such as Lehman Brothers and AIG, the collapse of SVB was not due to questionable business practices or imprudent investments. Rather, it revealed a more profound and alarming problem that lies at the heart of the banking industry. The crisis highlights how a lack of thorough auditing and stress tests allows banks to value their assets optimistically, which can obscure their actual financial condition and increase the risk of systemic instability.

In the case of SVB, its investments in mortgages and treasuries seemed to conform to industry norms. Unlike “bad” banks such as Lehman Brothers or AIG, SVB was considered a “good” bank, investing in mortgages and U.S. Treasury bonds. While it did invest in longer maturity Treasuries, this practice is common among banks, which typically borrow short and lend long. However, the primary issue was the lack of proper auditing by the Government that permitted financial institutions to hold Treasuries and comparable securities on their financial statements at hold-to-maturity values, creating an appearance of greater stability and value than could be actualized in the open market. This allowed banks to overinflate their assets which allowed them to take more liabilities in the form of deposits. As evidenced by the SVB crisis, the most significant problem for many banks is the mismatch between mark-to-market and hold-to-maturity valuations. Mark-to-market accounting entails valuing assets at their current market prices, while hold-to-maturity accounting allows assets to be kept on the balance sheet at their original value. This difference can lead to a misleading perception of security since the actual market value of these assets can fluctuate significantly. SVB’s case serves as an example, as a package of Treasuries was sold, unveiling that the actual value of the assets sold was $1.8 billion less than initially reported. The marked-to-market assets revealed a significant issue. The need for a more stable financial sector has become evident.

The cause of the SVB crisis can be traced back to the government’s policy enabling financial institutions to portray their asset holdings as more durable and stable than they truly are. When regulatory authorities allow banks to account for assets at hold-to-maturity values, this effectively creates the illusion of a strong financial standing. This policy may conceal the actual risk exposure of banks, leading to a misguided feeling of safety among depositors and investors. Moreover, as evidenced by the situation at SVB, the difference between the values held until the maturity of investments and the values marked with current market pricing can provoke a crisis. When it is revealed that the market worth of assets is much lower than reported initially, it undermines trust in the bank. Deposit holders become concerned about the bank’s liquidity and the safety of their funds, leading to a bank run. In the case of SVB, a significant portion of the deposits was not insured, worsening the crisis.

The Silicon Valley Bank collapse serves as a stark reminder of the vulnerabilities present in the American banking system. Government policies permitting banks to mark their assets to fruition may create an illusion of stability. This can lead to disastrous consequences when the actual market value of these assets is revealed. In response to the SVB crisis, the FDIC intervened by guaranteeing all deposits, dissolving the bank, and selling it to other financial institutions. This highlighted the systemic risks that this accounting practice can introduce. To avoid similar crises in the future, policymakers should reconsider the practice of allowing banks to hold assets at hold-to-maturity values and instead adopt more transparent and accountable accounting standards. By taking these measures, they can prevent potential bank failures and maintain the stability and integrity of the banking sector. In turn, this safeguards the interests of depositors and the broader economy. Perhaps, in the long run, we may even need to reevaluate and revise our entire banking system as a whole to address the structural issues that underlie these vulnerabilities and ensure the long-term stability of our financial institutions.

References

Kotlikoff, L. (2023, March 11). Why SVB’s Failure Is Really Scary. [Economics Matters]. https://larrykotlikoff.substack.com/p/why-svbs-failure-is-really-scary

Maurer, M. (2023, March 20). Banks, Investors Revive Push for Changes to Securities Accounting After SVB Collapse. CFO Journal. https://www.wsj.com/articles/banks-investors-revive-push-for-changes-to-securities-accounting-after-svb-collapse-99caa9ce

Peters, S. (2023, March 13). The SVB Collapse: FASB Should Eliminate “Hide-‘Til-Maturity” Accounting. CFA Institute. https://blogs.cfainstitute.org/marketintegrity/2023/03/13/the-svb-collapse-fasb-should-eliminate-hide-til-maturity-accounting/