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Lessons learned from a modern day bank run

The liquidity crunches at Silvergate Capital Corp. and SVB Financial Group highlight the risk of concentrations in a single industry and serve as important reminders for banks to diversify their funding sources, according to Todd Baker.

In the latest Street Talk podcast, recorded March 9, Baker, a senior fellow at the Richman Center for Business, Law and Public Policy at Columbia Business School and Columbia Law School, discussed the recent liquidity crunch at Silvergate, the asset/liability management lessons observers can learn from the turmoil and the risk that banks face when focusing on a given industry. Baker, who previously served as the chief corporate strategy and development officer at three large banks, also provided insight into the balance sheet repositioning at SVB Financial and severe stock selloff that followed.

Silvergate Capital on March 8 announced plans to voluntarily liquidate its banking operations after the crypto-focused bank sought to cover mounting deposit outflows through high-cost borrowings and selling securities at a loss. While volatility in the crypto business in the aftermath of FTX's fall exacerbated problems for Silvergate, Baker noted that the situation has some historical comparisons to banks that were heavily exposed to a single industry that experienced great stress.

"Crypto volatility in the business is the cause, but it's really no different from a situation you might have had in the 1980s or '90s with an oil patch lender that was overconcentrated in oil and gas exploration," Baker said in the episode. "It's just a bad idea for a bank to be completely concentrated in one industry. It never works from a risk management standpoint."

Baker further noted that Silvergate was also heavily concentrated in a business that had not operated through a variety of credit and interest rate cycles. Given the lack of history in the crypto sector, banks would have hard time making deposit outflow assumptions in a stressed scenario.

"What happened here is about crypto, but really isn't about crypto. It's about asset liability management and what the appropriate risk procedures should be in a bank and how much capital should be placed against us," Baker said.

Baker questioned if regulators should allow any bank to become heavily exposed to a single industry and have such large deposit concentrations. He said regulators tend to think in terms of credit risk and credit concentration rather than deposit exposure, but the lesson of Silvergate is that a bank's liquidity should not be that exposed to a single industry without carrying outsized capital and risk management measures.

"If it's so concentrated something wasn't working in terms of the risk management oversight at the regulators just as it was not working and the risk management oversight within the company," Baker said.

He further noted that banks always have the temptation in asset/liability management to boost earnings by reaching further out the yield curve. He noted that many banks have done that for the last decade without getting burned because interest rates remains relatively stable. However, in the face of rapid rate increases, most institutions' bond portfolios are now deeply underwater. Banks are also seeing greater pressures on liquidity and higher funding costs stemming from rate increases.

Baker said that some banks with perceived duration risk and exposure to venture capital took sharp hits in the market March 9 after SVB raised capital and purged its bond portfolio in the wake of seeing a higher cash burn among its clients.

Baker noted that SVB had a concentration issue as well given that it is so tied to the technology and venture capital industry. He said the institution has long seen outsized deposit growth during boom cycles and that influx of liquidity has always created challenges for the bank.

He said that SVB hoped that the sale of its available-for-sale securities portfolio would allow it to put the issue behind itself and improve its net interest margin going forward.

Since announcing the bond sale and related plans to raise capital, however, the bank faced greater deposit outflows, with its core depositors of venture capital-backed companies withdrawing. SVB reportedly tried to find a buyer, but California Department of Financial Protection and Innovation announced at midday March 10 that it took possession of its main banking subsidiary, Silicon Valley Bank, citing inadequate liquidity and insolvency.

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"Street Talk" is a podcast hosted by S&P Global Market Intelligence.

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This article was published by S&P Global Market Intelligence and not by S&P Global Ratings, which is a separately managed division of S&P Global.

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