While updates continue, the dust is settling from the initial failure of Silicon Valley Bank (SVB).
The email sent from the newly appointed CEO of the FDIC-protected “Bridge Bank” gives one the sense that last weekend was just a bad dream. However, while customers have been protected, and founders can finally breathe a sigh of relief, the banking world is facing a post-weekend hangover of a gargantuan scale.
SVB had infiltrated all areas of the modern economy, with fingers in so many pies that any misstep would create tidal waves that make FTX’s downfall look like a raindrop. The trigger of such chaos caught many by surprise – a “boring” banking mismatch of asset maturity.
Careless? Maybe. Greedy? Probably – Many believed the government’s intervention inevitable, but how such a failure even came to pass in such a heavily regulated sector is yet to be unveiled.
Some believe this could be an opportunity for alternatives to arise.
A backdrop of rate rises and deregulation
The Dodd-Frank Act has taken a leading role in setting the scene for the drama.
Passed in the wake of the 2008 crisis, the Dodd-Frank Act was the most far-reaching financial reform in US history. Aimed at preventing excessive risk-taking, it created several safeguards, including an annual “stress test” on banks with over $50 billion in assets.
In 2018 the Trump administration agreed to raise this threshold to $250 billion, allowing many large banks to escape more stringent regulation and scrutiny over activities.
SVB, along with many others, enjoyed the benefits.
Soon after, unprecedented conditions and resulting changes to the rate environment created fertile soil for the bank’s demise.
“This latest news makes it clear that the stress tests put in place since the financial crisis are still fundamentally inadequate,” said Prath Reddy, President of Percent. “Currently, they do not address interest rate sensitivities and basic ALM (asset-liability management) mismatches.”
“While the lower interest rate environment pushed banks to invest further out the curve, there was a lack of standard interest rate hedges that should have been put into place. Anyone watching their balance sheet should have seen this coming as the value of long-term bond holdings plummeted.”
“Regulation needs to regulate ALM and hedging activities – had the governing bodies mandated hedging interest rate exposure, this probably would not have happened.”
Derisking could be fintech’s golden ticket
While the ramifications of regulation are still unclear, the bedrock of modern banking has been shaken, and the industry has been left wandering on an unstable footing.
After a desperate day of deliberation following the initial bank run, the FDIC announced the creation of the Silicon Valley Bridge Bank. Customers’ deposits have been fully protected, making it the “safest in the country.”
However, SVB’s failure has caused leaders to question the system.
“With the formation of the FDIC “Bridge Bank,” the FDIC has essentially created a new mechanism for deposit insurance,” said Ben Munos, VP of Banking Operations and Product, Cogni. “The long-term effects of this are absolutely unknown, but one could argue that banks will be incentivized to continue making bad investment decisions, knowing they have a new mechanism for exchanging out of the money treasuries at par, in a time of distress.”
This realization has, for many, brought light to the fact that their inherent trust in large incumbents’ ability to manage risk could be unfounded.
“You bank at SVB as a founder, knowing the tech isn’t great, but thinking it’s the safest possible place to park your cash where there are institutional relationships with your VCs, where you can get debt,” said Don Muir, CEO of Arc. “That’s why you go to SVP – It’s the brand. It’s the prestige. It’s the gravitas.”
“That all was eroded, if not eliminated, over the last four days.”
The weekend events made one strikingly clear – the insufficiencies in the system for protecting businesses with assets over $250,000 parked in a single account.
“For the first time, operators, CFOs, and CEOs are scratching their heads and saying, wait a minute, maybe a traditional bank isn’t the safest place to park my cash, maybe I need to actually diversify my banking stack across a number of counterparties to reduce single counterparty risk,” said Muir.
“JPMorgan Chase is considered too big to fail. And that gives comfort to a lot of businesses. The reality is, through a technology platform, you can diversify away risk by working across a very broad range of bank partners within the network.”
He explained that since the news broke of SVB’s imminent failure, Arc had been approached by many of the bank’s customers, searching for an alternative for them to help diversify their banking stack.
He felt the crisis had marked a change that fintech is poised to capture. “The future of banking is digitally native. Fintech can provide a level of diversification that’s hard to achieve for an offline bank,” he said
“The shift you were seeing away from traditional offline banks towards digital banking providers was just accelerated by several years over the past four days.”
This opinion is echoed by others in the industry, who feel that the realization that regulated entities could still be vulnerable could work in fintechs’ favor.
“What you will see from fintechs, especially fintechs in business banking, is new mechanisms for auditing and evaluating the underlying banking partners that actually hold (and invest) consumer deposits,” said Munos.
“I would imagine all Fintechs are formalizing processes to review and monitor on an ongoing basis the risks each banking partner has to end consumers, regardless of what the government does or does not require in the future.”