Banks Aren't Banks Anymore

The broader issue behind the collapse of Silicon Valley Bank

For anybody who missed it, Silicon Valley Bank (SVB) went into receivership with the FDIC this past Friday after $42 billion of withdrawals were made on Thursday and pushing them into insolvency (at least short term).

At the immediate moment, anybody with deposits at SVB is in limbo, with only vague communication from the government about what to expect. Your money may or may not exist, and you may or may not get it back past the FDIC-insured limit of $250k. At least in theory, FDIC-insured funds will be available again tomorrow (Monday, the 13th).

There is a ton of commentary in the press and on social media. https://www.economist.com/finance-and-economics/2023/03/12/investors-brace-for-fallout-from-silicon-valley-bank Some of it is insightful, I would particularly note the stresses put on the banking system by the swift and dramatic rise in interest rates this past year. That has created a lot of financial pressure on banks that hold bonds and other assets tied to interest rates, arguably one of the root causes of SVB's collapse. Unfortunately, a lot of the commentary has also turned political and populist (there is a recurring schadenfreude-like undertone of SVB catering just to wealthy tech elites).

However, most of this commentary is missing a simple observation:

Banks aren't banks anymore.

Look at this in very fundamental terms. In today's digital age, we've all accepted the idea that our money, whether personal or for a business, is simply digital records stored somewhere--that is, at a bank. Unless your name is Walt, you likely don't carry around gold bullion or have stashes of hard currency in a self-storage locker.

The fundamental social contract with banks and their attendant regulators is that they will keep the money safe and available for you to use to pay bills, run payroll for your company, and everything else you use the money for on a day-to-day basis. 

Now, however, that premise is at risk. Thanks to social media and online banking, any bank is literally one viral tweet away from disaster. How many of the 4,000+ banks in the US could survive over 25% of their deposits being withdrawn in a single day, as what happened with SVB?

Not many, if any.

That's the crux of the issue. There will be plenty of worthy debate and discussion about how well SVB managed its assets, what role did certain VCs play in exacerbating and stoking panic, etc., and undoubtedly there may be some reforms at the surface level on some of those issues.

Unless we solve for a very simple and fundamental social contract: namely, that banks can safely store digital money for people and businesses, there will be another SVB-like bank run.

The challenge is in how to do that. Any solution is likely to have significant unintended consequences.

Having the FDIC fully insure every deposit (of any size) is, on the surface, a straightforward and obvious solution. However, that creates an extreme moral hazard for bank managers who may become recklessly risky. Even if that moral hazard is mitigated through regulations or other means, such a move would likely dramatically increase the US deficit by increasing borrowing costs. Treasuries have a lower yield, thanks to their safety. But what if Treasuries weren't the only game in town, and now any old bank account was just as good?

What if we fiddled with the FDIC insurance limit instead? Then the question becomes, "how much"? $500k? $1m? More? Whatever number is picked, there will be winners and losers. The current $250k threshold is arguably too low, even for small businesses. A mid-size restaurant will spend that much in a month between payroll, rent, food, etc.  

If the solution is to pick a new limit number, that will leave a gap for any account above that limit. What business will willingly put its working capital into a bank that could vanish in 24 hours? Thus, in this scenario, I expect we'd see a rise in fintech workarounds like Mercury.com, which aren’t banks themselves but instead aggregate deposits across multiple banks to increase the effective amount of insured funds.

Right now, uncertainty is by far our biggest challenge. Treasury Secretary Janet Yellen and the FDIC are not helping the situation at all with their ambiguity. Maybe they will do something, maybe not. At least they are working on it, and we may see announcements as soon as this evening.

Ideally, we'll see some action that stabilizes SVB depositors to prevent a system-wide run on smaller banks. That would give some breathing room for longer-term reform and improvements.

Hang on to your hats folks...