EXPERTS ADVISORY

University of Michigan experts can discuss the fall of Silicon Valley Bank, the federal takeover of that and another bank and what it all means for the financial industry and consumers.

Amiyatosh Purnanandam is a professor of finance at the Ross School of Business. His recent research is primarily focused on measurement and detection of risk in banking, incentive issues in financial markets, design of mortgage-backed securities and racial differences in access to finance.

“On the surface, SVB’s failure is a classic case of risk management failure on the asset side and imprudent funds management on the liability side,” he said. “A few years ago, the bank took a huge bet that interest rates would remain low for a sufficiently longer period of time. As the Fed began to increase interest rates, that bet failed. The value of the bank’s assets started to decline, eroding its equity and effectively making it bankrupt. At the same time, the bank got most of its deposits from customers in Silicon Valley. With the stock market rout in the tech sector, these customers began to withdraw their deposits.The double whammy of asset decline and deposit withdrawal was sufficient to bring the bank down.

“At a deeper level, the crisis has exposed some serious cracks in our financial regulation. We focus too much on complicated models to measure the level of risk a bank is taking. Such an approach, in my opinion, is bound to fail: Markets always figure out a way to get around risk-based regulations. As I have shown in my research, banks strategically underreport their risk and change their portfolios to look good on these risk models. A lot of research has come to the conclusion that there is a limit to such model-based regulation. Every crisis happens due to a new reason. However, there is always one thing that remains constant: Someone made too much money by taking excessive risk. Therefore, we need to regulate the incentives to take excessive risk.

“The essential components of such an approach is to focus on incentive compensation of the bank managers and aligning the incentives of shareholders with the taxpayers. If taxpayers bail out an institution, then the shareholders must share in the upside of the bank’s equity returns in good times. If reckless lending by an institution leads to a bailout, the managers of such institutions should not be allowed to work in the banking industry for some time. There are several such proposals that need a serious evaluation. We really did not make much progress on these fronts after the Global Financial Crisis and we are now paying a price for it.”

Contact: amiyatos@umich.edu

Joanne Hsu is the director of the Surveys of Consumers and a research associate professor at the Institute for Social Research. Her research is primarily in the fields of household finance, labor economics and survey methods, with a current focus on financial sophistication and cognition, and consumer experiences with debt.

“Federal regulators announced on Monday that all depositors at SVB would have access to their full deposits, even those in excess of the $250,000 covered by FDIC insurance, so the failure of SVB will not result in direct financial losses to clients,” she said. “These policy announcements were intended in part to shore up confidence in smaller regional banks like SVB and prevent bank runs like the one that imperiled SVB.

“As such, the immediate, the direct impact on consumers more broadly should be relatively limited, as the policy announcements today should mitigate similar threats to banks and their deposits. That said, stock values for many banks have fallen steeply, which impacts their shareholders. Time will tell how concerned consumers more broadly are about these developments in financial markets and whether their outlook over the economy or their financial behavior will be affected.”

Contact: jwhsu@umich.edu