What Went Wrong at Silicon Valley Bank?

One significant question: Was Silicon Valley Bank an outlier, or are a lot of other U.S. banks similarly vulnerable to a bank run? Gregor Matvos, a finance professor at Kellogg, and his colleagues Erica Xuewei Jiang, Tomasz Piskorski, and Amit Seru, recently conducted an analysis that shows the banking sector is more fragile than we might hope.

Kellogg Insight spoke with Matvos about the bank run, his analysis, and what this could mean going forward. Our interview has been edited for length and clarity.

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INSIGHT: Beyond the obvious—too many depositors all got spooked and tried to move their money at once—what happened here? What was the underlying cause?

Gregor MATVOS: In the last year or so, the Federal Reserve increased interest rates, which led to a decline in the value of the holdings of banks, the “asset side” of banks, as we call it. The loans they had made, the bonds they held, decreased in value.

INSIGHT: And why is that?

MATVOS: Well, think of it this way. You buy a government treasury bond two years ago when interest rates are close to zero that will repay over 20 years. Then the government starts issuing new bonds with interest rates at four percent. Obviously, you’d rather have four percent than zero percent. That seems like a no-brainer. Well, if the four percent bond right now costs you $1 to buy, then the bond you bought in the past surely is not worth a dollar anymore. It’s worth less because it’s giving you less interest payments over time. In other words, it declines in value. And the issue for banks is that not only have their securities lost value, but they also didn’t record these losses on the books. They pretended as though the value of these securities was the same as from the time when they issued them.

INSIGHT: Is that allowed?

MATVOS: Recognizing losses in a mark-to-market way has always been a little bit fraught with banks. The recognition of losses tends to be slow. Sometimes that’s okay; sometimes that’s not okay. The interesting question here is that the losses are quite substantial. So, uninsured depositors started getting worried. Imagine I’m one uninsured depositor, and I say, “Well, if all people like me pull out their money, is there going to be enough money left for me?”

Once people started worrying about there not being enough money, well, there may in fact not be enough money, and it makes sense to run. And that’s partly what happened to Silicon Valley Bank.

Now, what was especially interesting about Silicon Valley Bank is that its depositors were a tight-knit community in which the news of potential demise spread even faster than it normally would.

INSIGHT: So was there a specific trigger or did somebody just out of the blue say, “Hey, I think there’s a problem,” and then go tell their 50 best friends?

MATVOS: It’s always very hard to put your finger on a trigger. It was clear that banks were in slightly worse condition. Rumors started swirling, and then enough depositors redeemed that Silicon Valley Bank said, “We had to sell $20 billion of our bonds at a loss.”

I think that was actually a misstatement. They didn’t sell them at a loss, they sold them at market price. They just now finally had to acknowledge that the assets had lost value, which prior to that they had not done.

INSIGHT: Let’s talk about all these uninsured deposits. This would be any deposit over $250,000. So is the ideal scenario, then, for firms to just have 50 bank accounts so none go over $250,000?

MATVOS: Well, you want to think a little bit about who would have an uninsured deposit account, right? It could be a depositor who hasn’t really paid attention to where their salary is going, and more than $250,000 accumulates. Let’s call them “sleepy individual investors.” They quickly can readjust, and maybe send money to two banks or put money in Treasuries. For them, the deposits are a way of saving.

Another set of uninsured depositors would be something like charities or small businesses: You have to make payroll. It’ll be quite inconvenient to have your payroll spread across 50 banks. So you have one account with one bank, and you run your payroll through there, and you probably get your loan through there, and all the other services. It’s super convenient, and most of the time you really don’t have to worry about it. So we shouldn’t be that surprised that there’s uninsured deposits, because it’s practical for small businesses, charities, and so on to keep more than $250,000 in one place.

And if the banks have a big enough equity cushion—imagine that Silicon Valley Bank had been funded 20 percent through equity instead of 10 percent through equity—you can lose a lot of value and still not worry about deposits ever being impaired. But U.S. banks don’t do that. U.S. banks have more like 10 percent equity funding. That means that if asset values do decline, then all of a sudden, there’s a problem.

INSIGHT: In your analysis, you looked at whether Silicon Valley Bank is a complete outlier or emblematic of something broader. Can you tell us a little bit about your analysis?

MATVOS: We looked at data from all banks in the U.S. We first asked: These hidden losses, are they big? Are they small? Is Silicon Valley an exception? And we found that for the average U.S. bank, losses haven’t been mark-to-market on the order of 10 percent of their assets, which is substantial if you think that equity is about 10 percent of the assets.

So we said, okay, suppose Silicon Valley Bank defaulted just because of losses. How many other banks would default? Well, we find many would. In other words, Silicon Valley Bank wasn’t a particularly big outlier on asset losses.

It also wasn’t an outlier from the perspective of how much equity capital it had. Where it was really an outlier was in “uninsured leverage.” In other words, when it funded itself, it funded itself a lot with uninsured deposits. So it was a combination of losses and uninsured deposits that triggered a run. If you just had losses and not uninsured deposits, you’d probably be fine. If you just had uninsured deposits and no losses—which was pretty much the case for Silicon Valley Bank two years ago—you’d be fine. But having both losses and many uninsured deposits, well, they were not fine.

INSIGHT: You also looked at how many banks—through a combination of the above factors—would be vulnerable to a bank run. What did you find?

MATVOS: The way we try to evaluate who would be at risk of a run is we said, “Imagine that half of these uninsured depositors wake up and freak out. Like, ‘Oh my God, I don’t know what’s going to happen. Maybe I should pull out my money.’ And then you have to repay them. Is there enough money to repay the insured depositors so that FDIC won’t have to step in?” And we find that there are about 190 banks for whom if half the people ran, the bank would get shut down, and the other people who didn’t run would lose everything. So the incentives to run there would be enormous.

Now the FDIC should generally only protect insured deposits, which is why we factored that into our analysis. It now seems, because of the issues in the banking sector, that the government will guarantee all deposits. So there is no reason to run, because the FDIC will stand behind all deposits.

INSIGHT: So to recap, Silicon Valley Bank is pretty unique because it’s catering to these large Silicon Valley companies and is largely funded via uninsured deposits. But when you look holistically at its vulnerability to a bank run, it’s actually not as much of an outlier as we would want.

MATVOS: It’s still an outlier, but there are plenty of other banks, 186 to be precise, that sure look like they could be subject to a run.

INSIGHT: So that’s about five percent of the banks in America.

MATVOS: Yes. And we were trying to be fairly conservative. So, for example, we assumed that if people ran on the bank, you could sell the assets at zero discount, which we know doesn’t happen. But we said, okay, let’s try to give the banks a good shot.

INSIGHT: I want to zoom out to the big picture here. How did Silicon Valley Bank let this happen? Did they not understand that this was a possibility?

MATVOS: It’s a great question. What could Silicon Valley Bank have done to prevent this? They could have bought interest-rate insurance a couple of years ago. Had they done that, they would’ve been insured.

Or they could have held very short maturity securities. But then they wouldn’t have made very much money. Part of their issue specifically is they didn’t have tremendous lending opportunities: Their clients had too much liquidity. They had to park it somewhere, and they parked it with Silicon Valley Bank. And then the bank just invested in treasuries to earn something rather than completely zero.

But the broader issue is that banks are exposed to fluctuations in their asset values. If banks are very well capitalized, we don’t have the issue that we’ve just seen in the banking sector. For example, in some related work, we looked at the capitalization of financial intermediaries called “shadow banks” that offer a lot of loans in the U.S. but can’t take deposits. We found that these are funded with about 20 percent capital instead of 10 percent for banks. They have quite a lot of capital because they have no fallbacks. If U.S. banks had more capital, we wouldn’t be having this discussion right now.

INSIGHT: Are you envisioning a scenario where different banks with different business models or types of depositors should be held to different capital levels?

MATVOS: No, I think they should all be held to a higher capital level!

Look, of course we can go back to the drawing board, and we can keep trying to rewrite regulations, and maybe we can come up with something sensible. But U.S. history is littered with trying to write better regulations for financial intermediaries. And then in 2008, we realized house prices matter. And now in 2023, we realize interest rates matter, again, even though in the 1980s interest rates drove a third of the savings and loan industry—which is also banks—into default.

I’d probably sleep a little bit better at night as a taxpayer if capital requirements were higher. It just provides you a cushion if we get regulation wrong.

INSIGHT: What other long-term takeaways are you struck by in this particular incident?

MATVOS: That it’s hard to regulate banks! Banks provide a lot of really useful services. We need banks in our economy to move money from people who have too much of it—we call them savers—to people who drive our economy—borrowers. That could be consumers; that could be firms. So we need banking to operate well. It’s not like the financial industry isn’t already very heavily regulated. Medicine and finance are two of the most regulated industries in the U.S. The question is, can we come up with better regulation? Or should we just say that there’s an easier fix: if you want to take deposits, you need a little bit more capital. By a little bit, I mean five percentage points more, which banks consider quite a lot.