It's financial sector greed again

US and European regulators ignored basic risk management

- JAIMINI BHAGWATI

On March 27, the Silicon Valley Bank (SVB) was taken over by the First Citizens Bank (FCB), backed by considerable financial support from the US Federal Deposit Insurance Corporation (FDIC). A college friend asked me about what had led to the collapse of the SVB. The subtext of his question was that following the North-Atlantic financial Armageddon in 2008-2009, the additional US regulatory controls should have made such a bank failure impossible.

A summary explanation is that over the past several years regulatory red lines have been blurred in the US. For instance, the July 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act was diluted by the passing of the Economic Growth, Regulatory Relief, and Consumer Protection Act in May 2018. However, the SVB meltdown was not due to any sophisticated chicanery as in the case of Lehman Brothers. SVB had large stocks of long maturity bond and loan portfolios funded by short-term borrowings. Further, around 90 per cent of SVB's individual deposits were more than the $250,000 insurance cap of the FDIC. In short, highly risky bets were taken by SVB and other mid-sized US banks, which involved maturity mismatches between liabilities and assets.

According to media reports, about 4,700 US banks with assets amounting to $10.5 trillion may be facing solvency or liquidity risk due to similar practices.

The Federal Reserve is providing loans to such banks at the face value of their long-term assets, rather than at the much lower mark-to-market values.