Silicon Valley Bank and Credit Suisse: Is a Financial Crisis Imminent?

Demystify financial crises. After the last financial crisis, the world had become accustomed to dividing banks into systemically important institutions and less important institutions. Now banks are also triggering rescue operations that are unknown to a wider public.

In order for the state credit insurer to provide a full guarantee for the accounts of Silicon Valley Bank and Signature Bank, they had to be declared systemically important. The category was reserved for big banks and followed the admission that some institutions were so deeply embedded in the economy that their demise would have threatened the supply of credit and triggered a severe economic crisis.

This does not apply to the two defunct institutions. Financial investors and Silicon Valley giants initiated a successful campaign with two central arguments: The Facebooks of tomorrow would be nipped in the bud if their uninsured assets were not guaranteed by the state. And it would also start a run on banks from customers whose balances exceed the $250,000 state insurance limit.

The central bank has waited too long

The run on the banks was slowed by a full guarantee of customer funds and a quick Federal Reserve facility that provides uncomplicated liquidity. It must be doubted that bank customers of a less politically connected field-forest-and-meadow bank from Ohio would have been allowed to rely on the same donation.

With the demise of Silicon Valley Bank, the idea that banks inevitably dominate their core business, maturity transformation, was also disenchanted. The aim is to use the assets for lending and other forms of investment in such a way that a good profit jumps out and the bank customers still get their money when they want it. You don't need banks that can't do that. In this respect, the demise of the Silicon Valley bank is good news.

You can rely on the Federal Reserve – that's another myth that's being debunked. The central bank has waited too long with its interest rate reversal and tightened monetary policy all the faster. The long period of extremely loose monetary policy was probably the original sin that caused many players to throw financial discipline overboard. Money was easy to get. A more steady monetary policy would also have been easier for banks to manage.

Perhaps even more serious is the Federal Reserve's failure in its role as a banking supervisor. The problems that banks would have if large unrealized losses and a large proportion of government-unguaranteed bank balances came together were recognizable, at least to insiders. Nevertheless, the Fed did not intervene.

But the most important idea that has just evaporated is that US government bonds are not risky and therefore do not need to be backed by equity. As it turns out, they do not involve credit risk, but an interest rate risk that can come into play. After the financial crisis, banks were obliged to maintain slightly higher capital ratios than before the crisis. However, the concept of risk-weighted capital was maintained. This means that some of the bank's investments have to be backed by less equity than others because they are considered safer.

Solid only on paper

Incidentally, until the last crisis, mortgage securities and Greek government bonds rated triple-A were also considered safe. The real lesson of the last financial crisis should have been that we do not know the risks in the face of the deplorable inability to look to the future.

On paper, Silicon Valley Bank had a solid capital base. The regulation allowed it to buy the majority of the supposedly safe bonds with the assets of its customers, i.e. with debt. More than 90 percent of the assets were not guaranteed by the state deposit insurance. This made the bank more vulnerable to bank runs than most institutions. Significantly higher capital requirements would have mitigated the problem.

Recent statements from Congress raise concerns that the Byzantine rules of the Dodd-Frank Act will become even more complicated. Unfortunately, the simple solution of rigorously raising equity ratios cannot be relied upon. One would be just giving in to another illusion.