BY DR KUBI UDOFIA INFO@KUBIUDOFIA.COM
Exordium
Silicon Valley Bank (SVB) was shut down by Regulators, following a bank run. At the time of its closure, SVB was the second largest bank failure in U.S. history, and only became the third following the failure of First Republic Bank on 1 May, 2023. With a view to drawing lessons for stakeholders in Nigeria; this discourse analyses the failure and resolution of SVB, and how technology, digital banking and social media may increase the risk of bank runs.
The Run on SVB
A bank run occurs when Depositors make significant withdrawals at the same time, due to fear that the bank may fail and be unable to make payments. There is an implicit assumption in banking, that all depositors will not demand for payment at the same time. Consequently, banks often reserve a fraction of deposits, whilst the remainder are given out as loans or invested in securities.
SVB invested substantial depositors’ funds in long-term U.S. treasury bonds. Treasury bonds have an inverse relationship with interest rates, such that their values decrease when interest rates are high. Treasury bonds were attractive investments in the aftermath of the Covid-19 pandemic, when interest rates were lowered to stimulate economic growth. However, in recent times, the U.S. Federal Reserve has been raising interest rates to curb soaring inflation. These rate hikes significantly devalued SVB’s bonds. It also increased cost of borrowing, compelling SVB’s depositors to make withdrawals from SVB for their liquidity needs. SVB resorted to a firesale of $21 billion worth of bonds at a $1.8 billion loss, to cover deposit withdrawals. It also announced a plan to raise $2.25 billion, by issuing shares to shore up its balance sheet. This heightened concerns regarding SVB’s solvency, resulting in the withdrawal of over $42 billion within 24 hours. These withdrawals left SVB with a negative cash balance of $958 million.
There has never been a bank run in Nigeria. This does not imply that Nigerian banks are immune to runs. Instructively, one of the tools which the Central Bank of Nigeria (CBN) has put in place to pre-empt runs, is the cash reserve ratio (CRR). The CRR is the fraction of a bank’s total deposits which is mandatorily required to be reserved with the CBN. Whilst the U.S. presently has a reserve ratio 0.0%, Nigeria’s current CRR of 32.5% is one of the highest in the world. The extent to which Nigeria’s high CRR may assist in cushioning depositor runs is yet to be practically ascertained. The downside of Nigeria’s high CRR is that banks are unable to utilise these “idle” non-interest-yielding funds for any profitable investments.
A “Sprint” Fuelled by Technology, Digital Banking and Social Media
The speed and magnitude at which depositors withdrew funds from SVB was unprecedented. An estimated $42 billion (constituting 25% of SVB’s total deposits) was withdrawn within 24 hours. In comparison, in Washington Mutual’s case in 2008, $16.7 billion (constituting 9% of its total deposits) was withdrawn within 9 days. Technology, digital banking and social media played pivotal roles in the pace and magnitude of SVB’s run. Information and misinformation about SVB’s financial condition were easily shared real-time on social media. Depositors did not have to wait for early morning newspapers. Digital banking platforms provided SVB’s depositors with remote and easy access to their accounts for transfer of funds to safer lenders. Consequently, in contrast to past runs, there were no crowded bank halls with anxious and irritated customers.
SVB’s case has illustrated that technology, digital banking and social media may significantly increased the vulnerability of banks to depositor runs. The ongoing push by CBN for cashless banking in Nigeria is bound to further increase the use digital banking services across Nigeria’s banking space. Regulators and stakeholders must be conscious of the downsides of technology, digital banking and social media vis-à-vis bank runs. For instance, it is now possible for a run to occur outside banking hours i.e. at night, on a public holiday or on a weekend. Previously, this would have been practically impossible. Furthermore, a run may be maliciously induced on social media to undermine a bank, cause chaos in the financial system or sabotage the economy.
The speed in which the run on SVB played out is also very instructive. This was clearly driven by technology, digital banking and social media. The implication of this is that regulators may have very little time to respond to or deal with digital bank runs. It is therefore imperative for regulators and stakeholders to develop protocols (in advance) for effective, efficient and prompt response to digital runs. Censorship of social media is a sensitive and complex issue and may not be an option. However, other mitigation strategies such as temporary denial of access to online bank services, tentative transfer/withdrawal limits or temporary prohibition withdrawals may be explored.
Bail-out and Moral Hazard Risk
The maximum deposit insurance coverage in U.S. is $250,000 per depositor per insured bank. In SVB’s case, U.S. authorities made both secured and unsecured depositors whole. Approximately 94% of SVB’s $172 billion deposits were uninsured. In the 2008 financial crisis, over $700 billion of taxpayers’ funds were expended in bailing-out troubled firms. In contrast, U.S. authorities have emphasised that SVB’s resolution is at no cost to taxpayers. Rather, funds have been drawn from banks’ contributions to deposit insurance fund and a special assessment on banks. Furthermore, SVB’s resolution does not involve “bailing-out” shareholders or creditors. These parties have been wiped out and SVB’s $72 billion worth of assets have been sold at a discount of $13 billion to First Citizens Bank.
There are at least three concerns regarding SVB’s resolution approach. First, making uninsured depositors whole amounted to bailing-out some big venture capital firms, tech entrepreneurs and their portfolio companies. These parties constituted a substantial bulk of depositors whose deposits exceeded $250,000. Second, bailing-out uninsured depositors could create moral hazard, which is the incentive to engage in excessive risk-taking because the consequential cost would be borne in whole or part by others. Third, banks will eventually pass the costs of bailing-out uninsured depositors to their customers. Indeed, Andrew Bailey, the Governor of Bank of England, recently (and rightly) observed that “with all things relating to bank resolution, there is no free lunch!”
However, the above concerns were arguably outweighed by the objectives of promoting confidence and stability in the U.S. banking system. Loss of deposits by uninsured depositors would have eroded public confidence in the U.S. banking system and exposed it to a contagion. Extending coverage to both insured and uninsured depositors was aimed at stabilising the banking system. Put differently, making all depositors whole was a means to achieving the objectives of strengthening public confidence and promoting stability in the U.S. banking system.
Although there has never been a bank run in Nigeria, there have been notable bank resolutions necessitated by significant under-capitalisation of the banks. An estimated $3.83 trillion have been expended on bank resolutions in Nigeria since 2009 with approximately $1 trillion used for Skye Bank’s resolution in 2018. These resolutions were financed with public funds with the attendant moral hazard. Worse still, principal actors who drove some of these banks into financial difficulties were not held to account to serve as a deterrent to insurance-induced careless or reckless risk-taking.
After the closure of SVB, the U.S. Federal Deposit Insurance Corporation (FDIC) created the Silicon Valley Bridge Bank (SVBB) on 13/3/2023. SVB’s deposits and assets were promptly transferred to SVBB whist a buyer was sought for. On 26/3/2023, FDIC entered into a purchase and assumption agreement with First Citizens Bank for SVBB’s deposits and loans. Instructively, Nigerian regulators had adopted a similar resolution approach for Skye Bank (Polaris Bank) on 21/9/2018 and Spring Bank (Enterprise Bank), Afribank (Mainstreet Bank) and Bank PHB (Keystone Bank) on 5/82011. This approach ensured non-disruption of banking operations. It also gave all depositors uninhibited access to their accounts. Implicitly, it bailed-out uninsured depositors, whilst creditors were wiped out. However, in comparison with SVB’s case, for varying (tenable and untenable) reasons, it took relatively longer periods for the Nigerian bridge banks to be sold to investors i.e. Polaris (20/10/2022), Keystone (22/3/2017), Mainstreet (4/10/2014), Enterprise (15/10/2014).
The Role of Deposit Insurance
SVB’s case has rekindled the debate on the suitability of deposit insurance coverage limits. Deposit insurance aims to promote public confidence and stability in a banking system by protecting depositors against loss of deposits where a bank fails. Although inability to meet payment demands may be due to a run, preventing bank runs is arguably not a proper objective of deposit insurance. In reality, such “objective” may only be achieved by unlimited coverage i.e. full insurance of all deposits. Such unlimited coverage would disincentivise depositors with the largest deposits (who are more prone to runs) from participating in bank runs. A significant drawback of unlimited coverage is the attendant moral hazard. It would induce banks to engage in excessive risk-taking, whilst removing depositor discipline. Unlimited coverage would also require a humongous deposit insurance fund. As at October 2022, Nigerian banks held an estimated N43.05 trillion in deposits. The cost of such huge insurance fund would be borne by banks, which would ultimately pass them on to customers.
The maximum deposit insurance limits in Nigeria is N500,000 per depositor per commercial/merchant/non-interest/primary mortgage bank and N200,000 per depositor per microfinance bank. In defence of these coverage limits, sometime in 2021 NDIC claimed that 97.6% of account holders in commercial/merchant/non-interest/primary mortgage banks in Nigeria were fully insured. It stated that this accorded with the principle on coverage by International Association of Deposit Insurers (IADI). The IADI principle requires the coverage level to fully protect a large majority of depositors while leaving a substantial proportion of the value of deposits unprotected to exert market discipline. However, the IADI principle also requires the coverage level to be reviewed at least every five years, to ensure it meets public policy objectives of the deposit insurance system. Instructively, the N500,000 coverage limit for deposits in deposit money banks was fixed in 2010 – about 13 years ago.
An emerging trend or practice is for coverage limits to be overridden by a temporary regime of unlimited coverage where a systemically important bank is facing significant problems or in times of financial crises. Bridge banks have this effect. This promotes public confidence and stability in the banking system, objectives which outweigh the risk of moral hazard.
