The collapse of Silicon Valley Bank (SVB) one year ago heightened concerns about the stability of the banking industry and the broader economy, and it came amid a spate of other headline-grabbing bank failures.
The demise of the Santa Clara, California-based financial institution was precipitated by a perfect storm of events, including sudden, massive investment losses and depositors rapidly withdrawing large sums. The failed bank’s deposits and loans were later acquired by First Citizens Bank.
SVB primarily served clients in the tech and venture capital world, and had faced pressure as interest rates rose rapidly. How did SVB’s failure impact the technology industry and entrepreneurship, and what should be done to strengthen the financial system?
On the anniversary of the crisis, we asked Columbia Business School faculty to weigh in on these questions and share what lessons we can learn to improve the outlook for the banking and tech industries.
Here’s what they told us:
CBS: How did the SVB collapse impact the tech industry and entrepreneurship?
It added to the overall feeling that the VC market bubble had popped. While the overall downturn started in 2022, the collapse of SVB led to LP unease and lengthened the time that the VC market will take to recover. We also saw many more crossover investors retreat from the VC market, and SVB's collapse was at least a factor in this.
A positive impact is that many more founders and investors are now paying attention to cash management rather than just revenue. This is not something that founders were focusing on before. Many startups fail because they run out of cash (while still generating revenue), so I'm happy to see this renewed focus on the basics.
– Angela W. Lee, professor of professional practice
In my view it did not have a big impact. What really impacts tech industry and entrepreneurship is the elevated level of interest rates that raised the cost of VC funding, increasing pressure on getting to project profitability faster. Overall, this made financing of some projects harder, especially more risky ones and those that need more time to become profitable.
– Tomasz Piskorski, Edward S. Gordon Professor of Real Estate
CBS: What have banks and regulators learned in the year since SVB’s collapse?
I am concerned about the VC regulatory landscape in general. All of the regulation over the last decade has been towards increasing access to this asset class, such as the expansion of the accredited investor definition, the repeal of the Volker rule, the relaxation of solicitation rules, and the fact that 401K's can now invest in VC funds. While this is positive in the fact that regulators are democratizing access to this asset class, I do worry that there are not enough checks and balances on the other end.
– Angela W. Lee
The recent bank failures underscore the fundamental issue of banking vulnerability rooted in the extensive financial leverage employed by banks and their susceptibility to solvency runs due to higher rates and credit risk. A typical bank in the US — and there’s actually not much variation, whether it’s big, whether it’s small — is about 90 percent debt-funded. In other words, if you’re a bank with $100 million of assets, $90 million of that is debt and $10 million is equity. That means even a relatively modest decline in the value of your assets (e.g., by 10 percenet) can technically push you into insolvency, especially if depositors decide to withdraw their money out.
– Tomasz Piskorski
CBS: What are regulators doing to prevent a similar collapse in the future, and are their efforts enough?
In the near term, measures like the creation of the Bank Term Funding Program in March 2023 and potential blanket guarantees for uninsured deposits have mitigated the crisis and reduced the risk of acute deposit runs. However, these policies, primarily addressing liquidity shortages, do not tackle the fundamental bank insolvency risk. Therefore, in the short term, we propose a market-based recapitalization of the U.S. banking system.
In the longer term, banks could face more stringent capital requirements, aiming to enhance the resilience of the U.S. banking system against adverse shocks to their asset values. The current highly debated “Basel III endgame” proposal aims to address this by proposing increased capital requirements for the largest banks in the US. The CEOs of these top banks have criticized the proposal, expressing concerns that the proposed “Basel III endgame” rule would unjustifiably and unnecessarily increase capital requirements for the largest banks and that such increase can have adverse effects on aggregate lending and the broader economy.
Our research suggests three key implications for the overhaul of bank capital regulation and risk supervision. First, our work indicates that currently on average banks’ capital is about 25 percent lower than it would have been in the absence of safety nets embedded in insured deposit funding. This suggests the scope for increased capital requirements. However, if anything, these are smaller and mid-size banks that are much more financially leveraged than they would have been due to their access to insured deposit funding. These institutions are also currently more exposed to insolvency risks, and hence regulators could consider prioritizing an increase in capital requirements for smaller and mid-size banks.
Second, our work suggests that the overall impact of raising capital requirements on aggregate lending may not be as substantial as commonly stated. This is due to the diminishing importance of bank balance sheets in lending, given banks’ ability to sell their loans in various market segments and the potential migration of lending activities to non-banking institutions.
Third, regulators could adopt our methodology of assessing the bank risk due to banks’ exposure to interest rate and credit risk. This would enable them to conduct stress tests on the banking system to assess the potential for solvency runs by uninsured depositors in response to interest rate and credit shocks.
– Tomasz Piskorski