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Speculation and theorizing abounds about what caused the downfall of Silicon Valley Bank, the largest bank to fail since the 2008 financial crisis. Pundits point to a range of factors that contributed to the demise of what is now the FDIC-administered Silicon Valley Bridge Bank, N.A. Yet the chief lesson to be learned from the debacle is that the only way to avoid similar failures (and their attendant market contagion) is for our banking system to revert to a system of sheltered banking that separates deposits and investments, à la the Glass-Steagall Act.
Some observers have blamed the failure on poor risk controls, such as SVB's failure to hire a chief risk officer and the fact that its senior management worked from home. Another prevailing theory is that the bank played it overly safe (and paradoxically, compounded its risk), by retaining low interest government debt in a climate of monetary tightening by the Fed. Congressman Patrick McHenry described SVB's failure as the "the first Twitter fueled bank run," precipitated by a negative review by Peter Thiel and the ensuing panic among social media savvy tech-bros. Financial reformers blame the downfall on the steady gutting on Dodd-Frank regulations, such as Congress's 2018 "tailoring" of enhanced prudential standards to essentially exempt companies under $100 billion in assets, like SVB. Others suggest that the bank accrued unwieldy exposures to venture funds, buttressed by recent dilutions to the Volcker Rule and capital/liquidity requirement.
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To some extent, all of these theories are correct, as factors such as a lax risk control culture and market deregulation likely played at least some part in the collapse. Still, on a more fundamental level, none of these concerns gets to the real root of SVB's problem. That is, even if all of the perceived deficiencies of SVB had been ameliorated long ago, the bank could still have failed.
The uncomfortable truth is that every bank teeters on the precipice of possible disaster due to the inherent nature of fractional reserve banking. If the assets and liabilities of deposit-taking banks were instantaneously marked to market, with immediate calls for cash, most would prove to be insolvent. In theory, a bank run could beset virtually any bank at any time.
Yet, between the passage of the Glass-Steagall Act in 1933 and its partial repeal by the Gramm-Leach-Bliley Act of 1999, there were no major bank runs. Why not? Certainly the period book-ended by these legislative acts featured plenty of turbulence, including World War II, the Vietnam War, global decolonization, the formation of dozens of fledgling nation-states with negligible sovereign credit and the social upheaval of the 1960s. The answer is that the Glass-Steagall Act instantiated an era of sheltered banking, when depositors had confidence that their bank was stable.
Today, sheltered banking is long gone, as deposit-taking banks continue to seek golden nuggets in the cracks and fissures of the rickety Volcker Rule, which relentless lobbying has relegated to being an ersatz simulacrum of Glass-Steagall. Regulators try their best to temper these risk-seeking activities through costly and convoluted compliance mechanisms like stress tests, liquidity coverage ratios, prudential standards, net stable funding ratios and other technical mumbo-jumbo. These measures have been largely successful in the short time since the Great Recession of 2008, but their ability to forestall another major default like SVB is hardly certain.
The simplest, most reliable way to avoid bank runs going forward is to reduce depositors' collective fear of losing their money. Such a result can obtain only when deposit-taking banks return to sheltered banking – the kind of banking that instills confidence among depositors that their money will be safe. Today, only credit unions can credibly offer that service.
George Bailey managed to forestall a run on his family savings-and-loan in "It's a Wonderful Life," not by raising haircut-laden capital, hiring physicists to model risk or seeking rescue from the federal government, but rather by assuring his depositors that his activities were above-board and integrated into the community. Modern banks can return to Bailey-esque stability in their deposit-taking operations by acting more like credit unions: i.e., charging inflation-sensitive transaction fees, maintaining a sensible book of conventional loans and mortgages and completely eschewing investments, derivatives and (in the case of SVB) venture funds.
The greatest value of this style of sheltered banking is that it reduces the risk of market contagion. Even if a sheltered bank were to fail (say, due to over-exposure to low-interest receivables in a high interest rate environment), such a failure would not cause market contagion. Treasury Secretary Janet Yellen admitted as much at a recent congressional hearing, when she told Sen. James Lankford of Oklahoma that uninsured depositors at SVB merited federal reimbursement due to contagion concerns, whereas similarly situated uninsured depositors at community banks did not.
Of course, banks will not drastically adjust their operations on their own to comport with the tenets of Glass-Steagall style banking. Only the political will of Congress can yield such improvements. While we can hope that that political will materializes, in the interim, business owners who rely on uninsured deposits to make payroll, pay off credit lines and run operations should flock to the relative safety of credit unions.
Akshat Tewary Akshat Tewary, Esq. is an attorney practicing in New Jersey, a Financial Industry Regulatory Authority arbitrator and President of Occupy the SEC, a non-profit advocating for financial reform.
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