US bank regulation needs to enter the digital age

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Nearly a year after Silicon Valley Bank collapsed, it is tempting to dismiss the US regional banking crisis as very loud tempest in a relatively small teapot. After all, the damage was contained to a handful of failed lenders, the sector has stabilised and the KBW regional banks index has regained most of its losses.

Such insouciance would be a mistake. The crisis should serve as a wake-up call about the unanticipated dangers linked to online banking. The industry and its watchdogs must start preparing now if they are to prevent a larger disaster in the future.

After a string of bad decisions, SVB was ultimately toppled last March by a deposit run, a problem that is as old as banking. The basic business model involves a liquidity mismatch: banks take short-term money from depositors and make long-term loans and investments. If too many customers ask for their money back at once, any bank will struggle to come up with the cash. Should depositors panic, one run can destabilise other lenders.

What has changed is the speed with which these crises spread. Back in the Depression, Franklin Roosevelt was able to halt a month-long bank run by ordering lenders to shut their doors for a four-day holiday. In 2008, Washington Mutual went down after haemorrhaging $16.7bn over nine days.

This time, SVB’s depositors pulled out $42bn in 10 hours. Another $100bn was heading out of the door when regulators shut it down. One day later, Signature bank lost 20 per cent of its deposits, and other lenders looked shaky. The US government promptly declared a systemic emergency.

The difference now is digital. Not only do fears about banks spread like wildfire on social media, but customers can move their cash by tapping an app or clicking a mouse. That danger is only going to increase as instant payment systems spread.

There are tried and trusted ways to protect against this kind of problem. Government deposit insurance helps keep money in place because retail customers know their accounts will be protected in a bank failure. Global liquidity rules put in place after 2008 force the largest banks to hold enough easy-to-sell securities to cover 30 days of projected outflows. And the US Federal Reserve’s discount window provides a liquidity lifeline by allowing banks to borrow cash, using their long-term assets as collateral.

But none of that saved SVB, Signature or later First Republic. They relied heavily on big depositors, those with accounts too large to be protected by the Federal Deposit Insurance Corporation. That problem is only getting worse: US uninsured deposits have more than doubled from $2.3tn in 2009 to $7.7tn in 2022.

Both banks were also small enough to escape the post-crisis liquidity rules and each proved incapable of tapping the discount window. SVB did not have the right operational arrangements in place, Signature repeatedly tried to use ineligible collateral.

Banking watchdogs are trying to address these problems. The FDIC put out a paper last year exploring whether to raise the current cap on deposit insurance or remove it entirely. Global regulators at the Financial Stability Board are doing a “deep dive” into rapid deposit flight and whether more buffers might be needed.

Perhaps the most intriguing proposal came last week from a top US banking watchdog. Michael Hsu, acting comptroller of the currency, wants to create an additional five-day liquidity rule that would require banks to have collateral in place to borrow from the Fed to staunch a high speed run. Even better, he would force all banks to tap the discount window at least once a year, if only to prove that they can.

Banks don’t love these proposals, to put it mildly. Lifting the insured deposit cap would require the FDIC fund to be 70 to 80 per cent bigger, a jump the industry would have to fund. Large lenders already covered by the 30-day liquidity rule oppose having extra requirements on top, and lenders of all sizes are concerned about any new buffers that would shrink the funds they have available for lending and other banking business. They warn that bank runs will be with us as long as we have banks, and all the rules in the world won’t prevent greedy or misguided executives from making dangerous mistakes.

They are right on both counts, but cleaning up last March’s banking ructions, small as they were, cost the industry $16bn. Imagine the tab for a proper mess. If deposit runs are a fact of life, we had better find ways to slow them down before the entire system comes crashing down in the blink of a digital eye.

brooke.masters@ft.com

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