How Post-2008 Bank Rules Led To A 2023 Problem

Britain eliminated wolves well over a century ago, hunting them out of existence because they preyed on sheep, and sometimes humans. One consequence is that deer, with no apex predator, exploded in number, overgrazing land and killing off biodiversity. There are now calls to bring wolves back. There is a lesson here for the financial system. Curb one pest, and you might encourage another.

Here’s how that story applies to the collapse of Credit Suisse (CS) and Silicon Valley Bank (SIVB). Fifteen years ago, it became clear that lenders’ habit of funding themselves generously with fickle, short-term borrowing from financial investors had become a problem. Doing so had helped to sink firms like Lehman Brothers and Northern Rock. So regulators revised their toolkit, encouraging banks to lean on supposedly sticky sources of cash, like the money households and companies keep in their accounts.

Tinkering with the ecosystem promoted a period of calm, but has created unintended consequences. Corporate and wealthy depositors turn out to be flighty after all. Silicon Valley Bank’s technology-heavy customers attempted to withdraw $42 billion in a day. Credit Suisse’s deposits fell by more than one-third in the last three months of 2022 as anxious wealth-management clients fled. Lenders are no longer struggling with a wholesale funding exodus, like in 2008. But they’ve arguably replaced that problem with an overdependence on corporate and private banking customers, who can also take their money out in minutes.

Regulators will once again rethink their toolkit, but previous pest-control techniques won’t work this time. After the last crisis, the Basel regulations told banks to keep enough liquid assets to cover all their wholesale funding, as if every penny might be called on at once. For corporate deposits that exceed national deposit guarantees, they typically only need to keep 40% in liquid assets, and 10% if the customer is “high net worth.”

The logical thing would be to raise those coverage ratios to 100%, or something like it. That’s the equivalent of culling the deer that have run amok across Britain’s countryside. But if regulators started asking banks to back those deposits 100% with liquid instruments instead of loans, the amount of cash they’d have to hold would leave them little room to lend into the economy.

There’s no easy answer, and the problem is urgent. Online banking has made it easier for customers to pull cash, and social media amplifies financial panic. It’s clear that deposits can go quickly from friend to foe. But regulators and politicians ought to remember that eliminating predators brings new problems. Better to live alongside them, understand how they behave, and be prepared to lose the odd sheep.

Context News

UBS will rescue Credit Suisse in a deal worth about 3 billion Swiss francs ($3.3 billion), Swiss authorities and the two banks said on March 19. The smaller bank lost 138 billion Swiss francs of customer deposits between Sept. 30 and Dec. 31, a 37% decline. Clients of Silicon Valley Bank tried to withdraw $42 billion of deposits on March 9, according to a filing by the California Department of Financial Protection & Innovation. The lender had $173 billion of total deposits on Dec. 31, of which $81 billion were non-interest-bearing demand deposits.

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