NYU Stern White Paper -- SVB and Beyond: The Banking Stress of 2023
Starting in 2009, coalitions of willing NYU Stern faculty (and their colleagues) published four timely books examining financial instability and regulatory reform. The first—Restoring Financial Instability: How to Repair a Failed System—appeared during the financial crisis of 2007-09 at a time when the Federal Reserve was still working on the watershed stress tests which brought an end the emergency. Later books addressed the Dodd-Frank Act (2010), the failures of Fannie Mae and Freddie Mac (2011), and the CHOICE Act (2017).
SVB and Beyond: The Banking Stress of 2023, the next in this series, discusses the implications of the recent banking turmoil. Written by a set of Stern faculty (together with several non-NYU co-authors), the 10 essays in this volume analyze the financial and economic causes of the 2023 U.S. banking failures and propose specific remedies for the extraordinary supervisory and accounting failures that contributed to them. (One of us is a co-editor of the new White Paper; and both of us are contributing authors.)
The events surrounding the 2023 U.S. midsized bank panic are now familiar to many observers. The failed institutions made a fatal compound error: they funded a risky portfolio of long-duration assets with volatile, runnable liabilities (uninsured deposits). Put differently, bank risk managers failed spectacularly. Furthermore, supervisors either failed to detect these vulnerabilities or, once they did, failed to impose timely sanctions. So, in early March 2023, when uninsured depositors lost confidence in the viability of these banks, they ran (see our earlier post).
To contain the rapidly spreading panic, U.S. authorities explicitly protected uninsured deposits of the failed institutions (and implicitly protected others). That is, having failed to scrutinize these midsized banks closely in life, financial regulators nevertheless treated them as systemic in death. The resulting near-record losses to the FDIC’s Deposit Insurance Fund will add to the burden on surviving banks, who will have to replenish it through higher fees. Absent regulatory and supervisory reforms, the lessons that bank managers learn from these supervisory failures and bailouts will encourage greater risk taking that increases the likelihood of future instability.
Not surprisingly, the remedies that the authors of SVB and Beyond propose are wide-ranging. For example, following the successful example set by the Fed in 2009, they include a special early set of stress tests that would reveal how vulnerable U.S. banks are to one of the most likely risks they face—namely, an episode in which persistent inflation keeps interest rates high for some time even as economic growth weakens and unemployment rises. (Remarkably, the Fed has not incorporated such a “stagflation” scenario in its annual testing framework, including the 2023 tests that were just reported!)
Other proposals include: the joint regulation of capital and liquidity risks (to address the fatal compound risk at the root of the 2023 bank failures); accounting reforms to avoid a repeat of the egregious deviations of regulatory capital from actual balance sheet conditions; deposit insurance changes to reduce the incentive for and the spillover from runs on uninsured deposits; measures to reduce or eliminate the fraught lender-of-next-to-last-resort role played by the Federal Home Loan Banks that further delayed the day of reckoning for the failing banks; and a variety of measures to strengthen traditional capital and liquidity rules to make the financial system more resilient.
We hope that you will take the time to read SVB and Beyond: The Banking Stress of 2023, which is available as an e-book here. To whet your appetite, we conclude this short post by reproducing the e-book’s Table of Contents:
Prelude. Viral V. Acharya, Matthew P. Richardson, Kermit L. Schoenholtz, and Bruce Tuckman
Part I: The Banking Stress of 2023
Chapter 1. Overview of Recent Banking Stress: Viral V. Acharya, Stephen G. Cecchetti and Kermit L. Schoenholtz
Chapter 2. Underlying Macroeconomic Causes of Recent Banking Stress: Viral V. Acharya, Stephen G. Cecchetti, Kermit L. Schoenholtz, and Lawrence J. White
Chapter 3. Banks, Interest Rate Risk and Systemic Risk: Theoretical and Historical Perspectives: Matthew P. Richardson, Alexi Savov and Philipp Schnabl
Chapter 4. Silicon Valley Bank: Failures in “Detective” and “Punitive” Supervision Far Outweighed the 2019 Tailoring of Preventive Supervision: Bruce Tuckman
Chapter 5. Evaluation of the Policy Response: On the Resolution of Silicon Valley Bank, Signature Bank, and First Republic Bank: Richard Berner, Kermit L. Schoenholtz and Lawrence J. White
Part II: Proposals for Reform
Chapter 6. Restoring Confidence in the Banking System with a Stagflation Stress Test: Viral V. Acharya
Chapter 7. Expanding Mark-to-Market Accounting for Banks’ Debt Investment Securities and Regulatory Capital: Sehwa Kim, Seil Kim, and Stephen G. Ryan
Chapter 8. Revisiting the Design of Deposit Insurance: Stephen G. Cecchetti, Thomas Philippon, Kermit L. Schoenholtz, and Lawrence J. White
Chapter 9. The FHLB Role in the SVB and Related Debacles: Stephen G. Cecchetti, Kermit L. Schoenholtz and Lawrence J. White
Chapter 10. Strengthening Supervisory and Resolution Frameworks: Richard Berner
Appendix. Liquidity Risk in Nonbank Financial Institutions and in Systemically Important Markets: Richard Berner