On Sunday, March 12, Treasury Secretary Janet Yellen announced that all depositors of Silicon Valley Bank (SVB) would be made whole, the Federal Reserve would establish a term lending facility to alleviate liquidity pressure, and that the U.S. Treasury would be ready to deploy $25 billion from its exchange stabilization fund, if necessary. The Biden Administration’s goal: preventing bank runs at other institutions by assuring depositors across the country that their money was safe.
Yellen’s statements followed a harrowing 72 hours: On March 8, Silicon Valley Bank announced it had sold approximately $21 billion of its “available for sale” securities and planned to raise $2.25 billion to bolster its balance sheet. Rather than assure shareholders and investors, the announcement caused a steep drop in SVB’s stock price and generated panic among the bank’s depositors, who raced to move their money. On Friday, March 10, the Federal Deposit Insurance Corporation took control of SVB to guarantee insured deposits. On Sunday, a second bank fell when New York regulators took possession of Signature Bank. The collapse of SVB and Signature were the biggest bank failures since 2008—and the second- and third-largest failures of all time. Moves by other financial institutions to shore up First Republic Bank have helped to provide stability and restore confidence in the banking system, though the system still seems volatile
Policymakers, for the most part, have commended the actions taken by Treasury and the banking regulators to prevent further contagion. With the dust settling, policymakers will begin to assess what led to the failure and what should be done going forward.
The failure occurred in the banking system, but its effects will not stop there. The turmoil will affect and inform how the SEC and Congress approach venture capital and private market policy.
To understand how these conversations will play out, we’ll outline:
How we got here
Congress and federal regulators have launched investigations that will offer a more complete picture of SVB’s failure. For now, consensus centers on specific risks the bank undertook and factors that ignited those risks:
SVB’s business model: SVB focused on the innovation economy, and its deposit base mirrored the fortunes of its clients. In 2018, the bank had approximately $49 billion in deposits; this figure ballooned to $189 billion in 2021. Further, SVB’s client base was concentrated among large account holders. This means that more than 90% of the bank’s deposits were uninsured by the FDIC.
Bad investment decisions: Awash in venture cash in 2021, SVB invested a large portion of the bank’s deposits in long-dated, low interest bonds. As interest rates rose, the value of these bonds diminished. This meant that if a liquidity crisis forced the bank to sell these assets, it would be at a loss.
Flawed communications strategy: SVB’s attempts to reassure clients by communicating the asset sale and related fundraise had the opposite of the intended effect. Already smarting from the economic and psychological pain of rising interest rates and layoffs, the bank’s clients reacted instead with alarm.
The VC echo chamber: News travels faster than it did in 2008—especially in Silicon Valley. Venture capitalists like those who filled the ranks of depositors at SVB are Extremely Online. After rumors of deposit withdrawals began to circulate, they became known to almost everyone in the venture community within hours.
The government’s response
The regulators: Who they are and what they do
The FDIC: Created in the aftermath of the bank runs that generated the Great Depression, the FDIC guarantees deposits of up to $250,000. The FDIC examines and supervises institutions, and resolves failing depository institutions.
The Federal Reserve: The Fed is the central bank of the United States and is in charge of monetary policy. The Fed regulates and supervises Bank Holding Companies to ensure, among other things, financial stability, and it possesses emergency authorities under Section 13(3), which allow it to establish lending programs and provide other avenues of relief.
The Treasury: While not a direct regulator, the Department of Treasury is charged with maintaining a strong economy through managing the nation’s finances and protecting the integrity of the financial system; Treasury chairs the Financial Stability Oversight Council.
Washington policymakers wrestled with whether and what action to take, and they had to decide fast.
Leaving depositors to assume the unknown losses
If SVB failed without a buyer or a government backstop, depositors would likely lose some portion of their uninsured deposits (anything over $250,000). Operationally, this would also have impeded customers’ access to money: Companies would have problems meeting operating expenses (including payroll); individuals who banked with SVB may have had similar issues making payments and having the financial means to live their lives.
Beyond the direct impact on SVB customers, the Fed had to consider systemic implications. Seeing what was happening at the nation’s 16th largest bank, if customers of other banks lacked confidence their money was safe, they would withdraw it—feeding runs on those institutions— to deposit it in the largest, safest banks. One person’s decision to move their deposits to safety is a rational decision in a bank run, even though it exacerbates the run and ultimately undermines the collective good.
Rescuing depositors by guaranteeing their assets
Government intervention, however, would also set a new precedent.
Prior to the administration’s actions Sunday, deposit insurance only covered up to $250,000 in deposits, no matter the covered bank. That said, some financial institutions have a more implicit government backstop—systemically important financial institutions (SIFIs). These firms, which have more than $250 billion in assets, are deemed to be so large or interconnected that their failure would present a systemic risk to the economy. Consequently, they hold higher capital reserves and are subject to more intense scrutiny. Firms below $250 billion still carry the FDIC insurance coverage, but may be considered less safe compared to their larger, systemically important counterparts. SVB operated below that systemically important line of $250 billion in assets.
On a normal basis, regulators would assume SVB’s failure to be disruptive but not systemically problematic. This was even more likely to be the case given the relatively homogenous nature of SVBs client base.
In this case, the systemic impact, however, wasn’t counterparty risk or financial interconnectedness. It was psychological interconnectedness. If the 16th-largest bank could shutter in a day, Americans banking with small and medium-sized institutions might rightly wonder how safe their banks are.
As it became clear more runs were not only possible, but likely, the government stepped in. Even without a buyer, the government guaranteed all deposits, established a term lending facility, and previewed that the Treasury was ready to deploy capital if needed.
Policy path ahead
Policymakers, for the most part, have commended the actions taken by Treasury and the banking regulators to prevent further contagion.
Policymakers in Congress and the regulatory agencies will begin to assess:
What led to failure and possible contagion
Who was responsible
What—if anything—should be done going forward.
What went wrong
Above we outlined the events and issues that contributed to where we are today. Policymakers will probe further.
Congressional investigation:The House Services Committee and Senate Banking Committee are expected to hold hearings as soon as next week.
Federal Reserve review: Further, Federal Reserve Vice Chair for Supervision Michael Barr will lead review on the Fed’s role in failing to identify the risk and take action; his report will be released May 1. That report will likely inform the Fed’s plans on regulatory tailoring, capital standards, and supervisory posture.
Who is to blame
Most agree that SVB’s management failed to manage the institution during the changing market dynamics.
But among policymakers, the fingerpointing has also begun. Republicans put blame largely on the supervisory teams at the regulators, particularly the San Francisco Federal Reserve Bank, for failing to identify the risks. Democrats, on the other hand, are pointing to actions Congress took in 2018 to pare back aspects of Dodd-Frank’s regulatory standards and stress tests for regional and mid-size institutions relative to the larger systemically important financial institutions.
Expect political posturing, but a divided Congress will not pass new bank regulatory legislation.
The path forward
In the near-term, policymakers will need to stabilize a banking system where depositors continue to prefer safety and are moving deposits to larger institutions. On a medium- and longer-term basis, policymakers will need to reaffirm confidence in the entire financial sector by addressing an array of problems:
Preventing capital concentration: Depositors are fleeing to safety, meaning they are moving money to the largest banks believed to be both financially stable and have the implicit backing of the government. Had SVB been purchased by a larger bank, it would have directly led to that outcome; had SVB failed, it would have indirectly led to that outcome. Hard to solve without providing that implicit backstop to more institutions, but requires a political appetite—and regulatory oversight framework—for which few have the appetite.
Ensuring adequate oversight: Some assert the underlying regulations were not aggressive enough, while others note it was the supervisors’ failure in applying the existing regulations that enabled the failure. Congress will not pass a regulatory bill, but the Fed may adjust both its regulatory tailoring proposals and supervisory posture, which is already under review.
Higher consumer banking costs: The FDIC insures up to $250,000 for all depositors in most circumstances. That is backed—and potentially funded by—the deposit insurance funds, which derive from fees paid by covered financial institutions into the Deposit Insurance Fund (DIF). With the government now backing all deposits for SVB and Signature—and there is talk of expanding such coverage in more circumstances—this may increase the DIF fee assessments, which in turn may increase banking costs for consumers.
Regulating in a digital age: In 2008, Washington Mutual depositors withdrew $16 billion over a 9 day period. SVB bank depositors withdrew $42 billion in a single day. In a digital age, words, fear, and money move faster. Policymakers will need to wrestle with stemming a psychological interconnectedness and ability to move money so quickly.
Regulating social media: The digital age also enabled faster mass communication. Policymakers are expressing frustration with prominent individuals, largely venture capitalists, who took to platforms like Twitter to magnify fears, ultimately accelerating the run on SVB. We expect discussions around restricting types of speech, but it is hard to regulate. The SEC is likely to investigate comments and other actions in connection with securities trading.
Calibrating interest rates: Since summer 2021, the Fed has been raising interest rates to combat inflation. Given that the run on SVB was indirectly caused by rising rates, the Fed may face pressure to moderate its approach.
Implications for venture ecosystem
The failure occurred in the banking system, but its effects will not stop there. Critics of the private markets have already seized on SVB’s failure to malign the innovation economy and call for greater private-market restrictions.
SEC leverages turmoil to advance agenda on private markets
SEC Chair Gary Gensler has pointed to the recent bank failures as a reason to strengthen the guardrails on finance. Because this turmoil was driven by banking institutions that supported customers in the innovation economy and the digital asset space, Gensler may be emboldened to pursue an already aggressive rulemaking agenda to expand scrutiny of private markets and venture capital.
The SEC has a number of items on its rulemaking agenda that would increase scrutiny around private funds, including venture capital, as well as the private markets more broadly. SEC-proposed rulemakings targeting private equity and venture capital advisers would increase disclosures and liability around due diligence, and the agency has targeted examination efforts on the private fund industry. Other expected actions, including reforms to Regulation D, could impose more conditions for entrepreneurs and fund managers seeking to raise capital in the private markets.
Congressional agenda on private markets delayed, but remains a priority
Chairman McHenry remains interested in advancing legislation to expand investor access and bolster private companies’ access to capital, but SVB and its aftermath will delay that agenda. We still expect him to build on early hearings on these topics and seek to build bipartisanship around the legislation.
Carta’s policy team is focused on preserving a policy framework that supports the ecosystem.
Carta’s policy team is engaging policymakers to support the key pillars of the private market ecosystem. Expected SEC rulemakings could hinder access to capital and investment opportunities, so it will be critical to understand how any proposals affect the market and engage accordingly. In addition to defending what is working in the policy framework, Carta’s policy team is engaging bipartisan offices to build support around legislation to expand onramps for accredited investors, increase the size and investor caps for venture capital funds, and expand the scope of qualifying venture investments to include secondary transactions and fund-of-fund investments. We expect the Financial Services Committee to consider legislation sometime this late spring or summer, though we will still need to push Senate action. It may be harder to get bipartisan support in light of the recent events, but we will continue to push.