The collapse of Silicon Valley Bank and two other US banks and the forced sale of Credit Suisse represent a significant banking crisis, argues the Lab’s CEO, Jesse Griffiths. Unless central banks and regulators admit the mistakes they made that helped cause it and strengthen their actions to stop it spreading and prevent future crises, it’s a situation that could get worse.
By Jesse Griffiths, CEO Finance Innovation Lab.
The first major error, which helped cause the collapse of Silicon Valley Bank, was weakening the rules that were put in place after the global financial crisis of 2007–8 to try to prevent future crises. In 2018, under lobbying pressure from many banks, Silicon Valley among them, the US Congress lightened regulation for ‘mid-sized’ banks, forgetting that it was the collapse of such banks, particularly Northern Rock in the UK, that had helped spark the global financial crisis. Prior to the 2018 changes, any bank with over $50 billion of assets had to abide by the rules of the Dodd-Frank Act, which included regular stress-tests, the agreement of ‘living wills’ to help resolution in a crisis, and capital and liquidity requirements. The 2018 Economic Growth, Regulatory Relief, and Consumer Protection Act lifted or lightened these requirements for banks with under $250 billion in assets, which included Silicon Valley Bank. Had the provisions remained in place, the bad decisions that Silicon Valley Bank made that caused its collapse could have been picked up and rectified.
Secondly, global banking regulations failed to highlight the weakness of Credit Suisse or prevent it from becoming the first major global bank to fall in this crisis. In fact, according to the enhanced rules for what the Bank for International Settlements, the global club of central banks, calls ‘globally systemically important banks’, Credit Suisse looked just fine. Such banks had to hold even higher capital buffers than normal banks, which Credit Suisse did, and just days before they intervened, Swiss regulators were insisting that the capital and liquidity positions of Credit Suisse were strong. They may have been right about this, but they were wrong to suggest that this made it safe.
These failures show that regulations need to remain robust and efforts to weaken them must be resisted. In the UK, many are becoming concerned that the government’s ‘Edinburgh reforms’ could weaken existing post-crisis rules – such as ringfencing, which separates a bank’s high street operations from its riskier activities, and the Senior Managers and Certification Regime, which helps hold senior bank staff accountable for wrongdoing.
The Financial Services and Markets Bill, currently before Parliament, goes even further than the Edinburgh reforms, with a new requirement for regulators to prioritise the ‘international competitiveness’ of the financial sector. This risks making regulators into cheerleaders rather than watchdogs of the system, and will incentivise further deregulation. The Treasury recognised this a decade ago when it removed a similar objective from regulators’ mandates, saying that “there is a strong argument that one of the reasons for regulatory failure leading up to the [global financial] crisis was excessive concern for competitiveness leading to a generalised acceptance of a ‘light-touch’ orthodoxy”. Regulators should be re-examining the rules that were supposed to prevent these kinds of crises and be open to new ideas about how to strengthen them.
Finally, it’s clear that central banks have damaged financial stability through the aggressive interest rate rises they have used to try to combat inflation. Silicon Valley Bank became unstuck ultimately because of falls in the value of its bond portfolio, caused by rising interest rates. By continuing to raise rates, the Federal Reserve, Bank of England and European Central Bank have all signalled they will prioritise inflation control over financial stability – a very dangerous message to send when it is clear that the banking crisis is far from over. Several mid-sized US banks, most notably First Republic, are still at risk of collapse, and a recent academic study suggests that as many as 190 US banks would be in a risky position if half of uninsured depositors decided to flee.
The collapse of Lehman Brothers, which started the meltdown stage of the global financial crisis, happened a year after the bank run that killed off Northern Rock. Central banks, governments and regulators should learn the lessons of history: financial crises can build slowly and get a lot worse unless very strong action is taken. They should start by admitting their own role in this banking crisis.