Four Ways to Protect Small Businesses
Silicon Valley Bank’s (SVB) sudden failure is the second biggest bank collapse in U.S. history, by what was the 16th largest bank in the U.S. As its name implies, the institution catered to the tech sector, which has had a bumpy start to 2023. On Friday, the Federal Deposit Insurance Corporation (FDIC) took control of the bank’s assets. The bank’s receivership not only creates risk for small and midsized banks like SVB, but also for their largely small business customers that form the core of such banks’ clientele.
The Biden administration announced late Sunday, including via a Federal Reserve press release and a joint press release by the Treasury, the Fed, and the FDIC, that all depositors at Silicon Valley Bank (SVB) would be able to access to all their money on Monday, March 13. President Biden confirmed this announcement in an early morning address, and also indicated that the same protections would extend to depositors of Signature Bank. In order to provide liquidity and eliminate the need to sell stock at low prices to shore up balance sheets, the Fed also announced the creation of a new Bank Term Funding Program (BTFP) to eligible financial institutions that pledge qualifying assets as collateral. The BFTP is backed by up to $25 billion from the Exchange Stabilization Fund.
The key takeaways are that: (1) all depositors at these financial institutions, even those above the FDIC-insured limit of $250,000, would be protected and have immediate access to their money; (2) the new BTFP was created to provide much-needed liquidity to affected financial institutions; and (3) the Federal Reserve discount window, which lends money to depository institutions secured by a wide range of collateral, remains open and will apply the same margins used for the securities eligible for the BTFP. This is all very good news for companies in the tech sector that need to make payroll by March 15 and would not have been able to do so without timely access their accounts.
These moves constitute an unusual “systemic risk” intervention aimed to avert a crisis in the financial system by taking control of the affected banks and protecting depositors. Further, under these programs, bank equity and debt holders, together with bank management, would not be protected, and no losses associated with the resolution of SVB will be borne by the taxpayer. In this way, the recent government moves are very different from the 2008 bank “bailouts” that were widely criticized for rewarding bank management and making taxpayers foot the bill. Senior management of SVB has also been removed. Any losses to the Deposit Insurance Fund to support uninsured depositors will be recovered by a special assessment on banks, as required by law.
Silicon Valley Bank’s spiral began on Wednesday of last week when it surprised investors by reporting in an SEC filing that it needed to raise $2.25 billion to shore up its balance sheet.
SVB’s clientele featured a high concentration of tech companies, making it unique among banks of similar size. Other midsized banks have a more diverse client base and cater to businesses of all types, such as restaurants, hotels, retail, manufacturing, and shipping.
In 2021 and 2022, tech companies raised a lot of money from VCs or went IPO, so SVB’s deposit base jumped astronomically from almost $16 billion to $200 billion very quickly. The Wall Street Journal reported that 2021 was SVB’s most profitable year ever. However, an estimated 85% of its deposit assets were uninsured (i.e., above the FDIC insurance-coverage threshold), according to recent regulatory filings.
With rising interest rates, and SVB heavily invested in U.S. treasuries, money went into servicing debt. More importantly, the rising rates seriously devalued SVB’s debt portfolio, and this exerted tremendous pressure on its balance sheet. To make matters worse, many startups had burned through too much of their money and were not generating much cash, thereby making them dependent on their SVB deposit accounts to keep funding their operations. As a number of tech companies were in this position, government intervention was required to try and prevent a domino effect in the economy, both as to affected banks, their business clients and their employees.
On the surface, SVB seemed stable as it had plenty of assets. The bank’s big problem, however, was liquidity. The bank invested in longer term U.S. treasury bonds in search of returns because rates were so low on short-term bonds. The Fed, in an effort to curb inflation with tightening monetary policy, has continued to raise interest rates over the past 12 months.
This persistent rise in rates was a big shock to the banking system, which had become accustomed to near-zero interest rates for a decade in the aftermath of the 2008 financial crisis and then again after COVID shutdown the economy. Looming on the horizon is the Fed’s next FOMC meeting (March 21-22), when the central bank could raise interest rates again, as it recently indicated it would do. Whether the Fed will follow through on this and raise rates again in the current environment is open for debate.
On the CBS show, Face the Nation, Treasury Secretary Janet Yellen said that America’s economy relies on a safe and sound banking system that can provide for the credit needs of our households and businesses.
“Whenever a bank, especially one like Silicon Valley Bank with billions of dollars in deposits fails, it’s clearly a concern. From the standpoint of depositors, many of which may be small businesses, they rely on access to their funds to be able to pay the bills that they have, and they employ tens of thousands of people across the country,” Secretary Yellen said. “We’ve been hearing from those depositors and other concerned people this weekend.”
“In the aftermath of the 2008 financial crisis, new controls were put in place (to ensure) better capital and liquidity supervision,” the Treasury Secretary said. “It was tested during the early days of the pandemic, and proved its resilience so Americans can have confidence in the safety and soundness of our banking system.”
“We want to make sure that the troubles that exist at one bank don’t create contagion to others that are sound. Our goal always is supervision and regulation to make sure that contagion can’t occur,” Secretary Yellen said, adding that the government was not looking to bailout SVB. The Treasury Secretary also said the government is looking at a wide range of options, including finding a buyer for SVB.
U.S. Rep. Ro Khanna (D, CA-17) represents the Silicon Valley area in Congress. He has stated that the government must act quickly and decidedly and provide the FDIC with maximum flexibility and tools it needs to close a sale. He told CBS’s Margaret Brennan that the government must ensure that all depositors are protected.
“Right now, the key thing is for the depositors to have access to those accounts,” Rep. Khanna said. “Let’s talk about who these depositors are. They’re not just the payroll companies; (there are) 50,000 of them and they’re employing Americans across the country and abroad. They didn’t take risks; they just had their money in a bank, and we’re saying those need to be guaranteed.”
What Should the Government Do Next?
As the FDIC, the Fed, and the Biden administration look to stem the fallout from the FDIC takeover of SVB and Signature Bank, it is important that they focus not only on the structural integrity of the small and midsized banks and the avoidance of contagion in this sector, but also on what they can do to protect the small businesses that are the core clientele of these banks.
One interim step to limit the scale and impact of such an event is to increase the FDIC’s commercial insurance cap from $250,000, which is much too low, as we have seen. It has not been raised in decades. As we have seen before, much of the momentum in “run on the bank” scenarios is the panic that spreads word-of-mouth among bank clients that are uninsured depositors. This fiscal insecurity would be reduced as the FDIC insurance threshold increased.
Second, the government must make clear that it will stand behind small and midsized banks, or else depositors will take their money out and put it into the big four banks (JPMorgan Chase, Bank of America, Wells Fargo, and Citibank) or other large banks, which would unintentionally create additional – and undesirable – concentration in the banking industry. A run on these smaller banks would be devastating to the economy. Further, midsize banks and small banks are instrumental in bringing equity to small business lending. We saw historically – and especially during PPP – that big banks will avoid risks and cater to large customers with whom they have deposit relationships. For this reason, and for the health of the economy as a whole, it is essential that all depositors, including the “uninsured” depositors with accounts far in excess of the $250,000 FDIC insurance threshold, see these smaller financial institutions as viable alternatives to big banks without risk.
Third, the FDIC should consider imposing additional capital requirements on small and medium-sized banks that cumulatively form a huge part of the banking sector but that individually fall below the threshold of Basel III developed by the Basel Committee on Banking Supervision. While these protocols are likely not appropriate for smaller banks, similar capital or investment guidelines should be considered. For example, Signature Bank assumed additional risk by investing heavily in crypto.
Last, the government needs to be mindful of how much money it is spending, which, of course, contributes directly to inflation. Unfortunately, the economy is in no shape to lower interest rates right now and trigger additional inflation risk. However, if the government keeps pumping money into the economy and inflation persists, the Fed will have no choice but to continue raising rates, even if it does so more incrementally. Naturally, this would both put small businesses that are looking for capital in a crunch, and further depress the balance sheet of banks that, like SVB, had invested heavily in long-term U.S treasuries. As PPP demonstrated, small businesses’ ability to access capital is essential to ensure the health of the American economy as a whole.
In addition to the salutary steps taken by the Fed, the FDIC, and the Biden administration, as discussed above, I believe the four next steps noted above would provide much-needed additional protection for small businesses that would be the most directly affected by failures in the small and midsized bank sector. These small businesses are the lifeblood of the American economy, and their ability to efficiently access capital is often the lifeblood of those businesses.
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