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The venture capital world is shiveringand regional banks across the country felt the PAIN after the second and third largest bank failures in the history of the US took analysts to surprise last week. But we were warned.
In October 2019, Martin J. Gruenberg, a member of the board of the Federal Deposit Insurance Corporation (FDIC), gave a speech titled “An Underappreciated Risk: The Resolution of Large Regional Banks in the United States” at the Brookings Institution’s Center on Regulation and Markets, in Washington, DC
He told an audience of scholars and regulators that he hoped to “draw attention to the challenges posed by the failure of a large regional bank,” arguing that the topic of increasing risks in these banks “received relatively little attention” in the years following the Global Financial Crisis (GFC) because regulators focused too much on so-called globally systemically important banks.
Regional banks, or those with assets between $50 billion and $500 billion, “present significant challenges to the FDIC,” Gruenberg said. “Their size, complexity, and reliance on market funding and unsecured deposits will present significant resolution risks, with potential systemic consequences.”
Today, the economy is experiencing the FALL from ignoring Gruenberg’s warning. Two of the banks that failed last week, are startup-focused Silicon Valley Bank (SVB) and the crypto-focus Signature Bank, are highly exposed to rising interest rates and credit risk, and their customer deposits are often uninsured. At SVB, about 93% of all deposits exceed the $250,000 FDIC insurance limit, according to Bloomberg. The problem of unsecured deposits is widespread. US banks will have more than $1 trillion in uninsured deposits by the end of 2022, according to an Insider analysis.
In his speech, Gruenberg went on to detail the many post-GFC regulatory changes in regional banks that have increased risks for depositors and the overall financial system. He noted that in April 2019, the FDIC eliminated the 2014 “liquidity coverage ratio” for banks with assets between $100 billion and $250 billion. That regulation requires all banks to hold sufficient quality liquid assets to fund 30 days of cash outflows. Meanwhile, for banks with assets between $250 billion and $500 billion, the liquidity coverage ratio is lowered to 85% of the previous limit.
“Given the risks associated with the failure of large banks in the region, these measures are unjustified and wrong,” Gruenberg said. “They only increase the challenges presented by the resolution of these institutions and the potential for catastrophic failure, and ignore the lessons of the financial crisis.”
The FDIC board member concluded with a warning, arguing that regulators have “an unreasonable sense of confidence” that the failure of a regional bank “will not be challenged.”
“I believe that the experience during the crisis of a large regional bank failure…shows the real risks that a regional bank failure would present,” he said, referring to the economic fallout from regional bank collapse. IndyMac in 2008, costing depositors billions, harming local communities, and resulting in “the largest Deposit Insurance Fund loss in FDIC history.”
“Going forward, I believe that addressing this issue should be a top priority for the FDIC, for other federal and state banking regulatory agencies, and for the banking industry,” Gruenberg warned. .
Warning ignored, fallout incoming
The “contagion” among regional bank shares following the collapse of SVB and Signature Bank was stated on Monday. The iShares US Regional Banks ETF—which tracks US regional bank stocks—cratered 14%, and exchanges were forced to stop trading of many individual bank stocks in the region.
Shares of West Coast banks were hit the hardest. First Republic saw its stock tank another 61% on Monday after a 33% decline last week, while shares of PacWest The Bancorp and Western Alliance Bancorp sank more than 21% and 47%, respectively.
Investor fears also spread to the broader financial services sector. Parts of Bank of America decreased 5.8%, Wells Fargo decreased more than 7%, and Charles Schwab cratered at 11.5%. However, the effects of the banking sector’s weakness extend beyond the stock market.
Richard Saperstein, chief investment officer of the investment firm Treasury Partners, said luck that he expects “tighter lending standards,” “cautious investment” by venture capitalists, and a reduction in economic activity ahead. And Wedbush technology analyst Dan Ives said that while the near-term systemic impact of regional banks’ problems is “less likely” now that the Fed has guaranteed SVB’s deposits, he fears that the tech scene- it will change forever.
Thousands of startups and more than 1,000 private equity funds and venture capital funds, including the likes of Andreessen Horowitz, will hold capital in Silicon Valley Bank by 2022, according to a luck analysis.
“We heard from many nervous VCs and tech startups over the weekend that they are worried about their employees, salaries, and the uncertain financial world they face going forward post SVB,” wrote Ives said in a research note on Monday. “The impact from this past week will have significant ripple effects throughout the tech landscape and Silicon Valley for years to come in our opinion.”
Ives added that a “tighter overall funding environment” will force many startups to cut costs and make banks look at second lines of credit extended to “unverifiable -an technology startup with a high cash burn.”
On top of the pain already felt in the stock market and in Silicon Valley, some fear that the failure of SVB and Signature Bank could trigger a recession. Jay Hatfield, CEO of Infrastructure Capital Advisors, said luck that he believes the Fed’s rapid interest rate hikes over the past 12 months intended to curb inflation have created a “financial panic.” Officials should reverse the trend and implement an “emergency rate cut” to prevent recession and improve the banks’ balance sheets.
“In the looming financial crisis, the risk of a recession is much higher than the risk of moderate inflation,” he warned, saying that “the last financial crisis led to the loss of economic dependence, many layoffs, and a deep and long recession.”
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