How US Bank Regulation Failed SVB and its Supervisors

Abstract

It is well known that Silicon Valley Bank failed in March 2023 because of a toxic combination of uninsured deposits and underwater securities. This article argues that the bank's failure could have been avoided if it had been subject to two global standards established by the Basel Committee on Banking Supervision. First, the interest-rate risk in the banking book (IRR-BB) standard, never fully implemented in the United States, would have identified the bank's extremely risky asset-liability management strategy and required remedial action 10 quarters before it failed. Second, the liquidity coverage ratio (LCR), from which U.S. regulators had exempted banks of SVB's size, would have required the bank to hold tens of billions of dollars more liquidity at least four quarters before it failed. The article also argues that the Federal Deposit Insurance Corporation (FDIC) would have saved $13.6 billion if SVB and other banks that failed in 2023 had been subject to the Basel Committee's total loss absorbing capacity (TLAC) standard, which requires banks to issue bonds that can be converted to equity. SVB's failure resulted in official sector protection of uninsured depositors through the US authorities' invoking of the systemic risk exception and the Federal Reserve's creation of the Bank Term Funding Program. Given public expectation of government and central bank policy intervention in a crisis and elevated levels of US public sector debt, bank supervision must emphasize ex-ante crisis prevention. The conclusion is that US bank regulation needs to include quantitative limits on interest-rate risk, liquidity risk, and TLAC for more US banks-not just the most systemic US banks. Such rules are particularly important given ongoing risks related to still above-target inflation, Treasury market fragility, growing risks to investor confidence in Treasuries, and the Fed's use of unconventional monetary policy, which increases the volatility of both US banking system liquidity and uninsured deposits.

Keywords: bank supervision, bank regulation, Silicon Valley Bank, interest-rate risk, liquidity coverage ratio, total-loss absorbing capacity

JEL Classification: G21, G28