The 2023 banking crisis, sparked by the collapse of Silicon Valley Bank (SVB), sent shockwaves through the financial system. While the Federal Reserve's proposed "Basel III endgame" regulations aim to bolster bank resilience, they might miss the mark on addressing the core issues exposed by last year's events.
Beyond Subprime: A Different Kind of Risk
The Basel III reforms, a global overhaul initiated after the 2008 financial crisis, focus on strengthening capital requirements and preventing risky lending practices like those associated with subprime mortgages. However, the 2023 crisis stemmed from a different vulnerability: interest-rate risk. As the Fed aggressively raised rates, the value of bonds held by banks like SVB plummeted, leading to liquidity problems when depositors withdrew funds seeking higher yields elsewhere.
The Panic Factor: Big Accounts, Big Impact
While the image of bank runs traditionally depicts frantic individuals storming bank doors, the reality is far more nuanced. Large accounts, often managed electronically, played a more significant role in the recent crisis. Data suggests major corporations with significant deposits were the primary drivers of these runs, similar to incidents in 1984 and 2008.
Rethinking Deposit Quality
Current regulations struggle to accurately assess deposit quality. Factors like customer relationships and a bank's business model are crucial, but difficult to quantify. Re-evaluating the status of specific deposit categories, such as those tied to volatile sectors like cryptocurrency or concentrated industries like venture capital, is essential.
Held-to- Maturity Accounting: A Double-Edged Sword
A prevalent accounting practice, "held-to-maturity" (HTM), allows banks to avoid reflecting fluctuations in the value of certain securities in their capital levels. While this shielded them from short-term losses during the rate hikes, it masked the potential capital hits if banks were forced to sell these assets to meet deposit outflows.
A Call for Reform: More Than Just Basel III
The Basel III endgame proposal doesn't fully address HTM. While it increases capital requirements for certain securities, a significant portion of bank holdings remain shielded by this accounting method. A potential solution lies in tying HTM usage to a bank's deposit stability, assessed by regulators.
Beyond Capital: Liquidity is Key
Preventing banks from resorting to fire sales of assets during a crisis requires enhancing their access to liquidity. Tools like the Fed's discount window, where banks can borrow against collateral, can be crucial. Regulatory efforts focused on encouraging pre-positioning of collateral at this facility could help banks weather future storms.
The Inevitable Next Crisis
The financial landscape is constantly evolving, and future crises will likely have unique characteristics. While past reforms address some vulnerabilities, the 2023 episode underscores the need for regulations that effectively manage interest-rate risk, assess deposit quality, and bolster liquidity options. By proactively addressing these blind spots, regulators can help build a more resilient banking system prepared to face whatever challenges come next.
