Bank failures in the US: “There is no reason for this to spread to Europe”

Until last week, almost no one knew their names. However, the bankruptcy announcement of Silicon Valley Bank, followed by the failures of Silvergate and First Republic, smaller but known for their privileged ties to the crypto community, sent stock and financial markets into massive turmoil. a week. Economy Minister Bruno Le Maire wanted to reassure on Monday, March 13, explaining that there is no risk of infection in France. “The reality is that the French banking system is not affected by the SVB. There is no connection between the different situations.” in the United States and Europe, he said when asked about the decline in European bank stocks, especially French BNP and Société Générale. But any forecasts in financial matters are uncertain. To find out more, TF1info contacted Ekaterina Lubochinskaya, professor of economics at the University of Paris 2 and member of the Circle of Economists.

TF1info: Four American banks went bankrupt last week. What exactly happened?

Ekaterina Lyubochinskaya: Silicon Valley Bank (SVB) was the bank for Silicon Valley companies (it was the banking partner of nearly half of the venture capital-funded startups, editor’s note). In two years, from 2020 to 2022, deposits in this institution have grown from $74 billion to $198 billion. At the time, it was the golden age of Silicon Valley. Except that in 2022 the US central bank, the Fed, raised its rates. This led to the deflating of the bubble around technology startups, which were previously overvalued. When these companies (customers of SVB — ed. note) wanted to collect funds to continue their activities, the bank was unable to return the money.

To be clear, when you make deposits at a banking institution, the latter uses them to fund the economy, make loans, or buy securities. However, when rates rise, the value of bonds automatically decreases. Silicon Valley then sold its government bonds for $21 billion, resulting in a loss of $1.8 billion. At the same time, the bank announced that it was going to continue the capital increase to recreate its own capital. Customers began to worry and rushed to return their money.

To sum up, firstly, this bank managed its liquidity ratio very badly. Secondly, as Bruno Le Maire noted in his speech, there has been a concentration of activity in the technology sector. Whereas in finance, the number one principle is diversification. In short, this is a very poorly run bank.

Why didn’t US regulators foresee the failure of the Silicon Valley bank?

Ekaterina Lyubochinskaya: What is surprising is that the alarm was given very late. As of the end of 2022, the bank had $15 billion in potential losses on debt securities and $12 billion in equity. Potential losses exceeded the bank’s own capital. However, no one sounded the alarm. In addition, the head of risk management stepped down in April 2022 and was only replaced in January 2023. In other words, the bank has been working without a head of risk management for more than six months.

European stock markets closed sharply lower on Monday, as did major bank stocks. Should we be afraid of infection, as some experts fear?

Ekaterina Lyubochinskaya : Bankruptcies have always been and will be. It is important that these bankruptcies do not have consequences for the economic and financial system, that is, they do not have a systemic dimension. The markets are worried because we still remember the 2008 financial crisis. Fear is the famous domino effect, i.e. bank A will fail, and the problem is that bank B lent him money. Thus, Bank B will not receive a refund and will suffer losses.

Another possibility is that American or European banks own one of these banks. However, it is not. I am not a soothsayer. However, if we look at things rationally, there is no reason for this to spread to Europe and for an international financial crisis such as the subprime crisis in 2007 to cause a global recession. Well, markets are not always rational, quite the contrary.

Do you think the risk of infection is limited, in part because we have learned the lessons of the 2008 crisis?

Ekaterina Lyubochinskaya: The collapse of the Silicon Valley bank highlights the importance of regulation. After the 2008 crisis, the rules were tightened, as was supervision. We have introduced higher equity ratios and integrated the calculation of risk based on traditional banking interest rates. The Europeans used it well. But the Americans, faced with the banking lobby, have ruled that any bank with assets of less than $250 billion is not subject to this regulation. All the major US international banks applied these new rules, but not the smaller ones.

US President Joe Biden assured on Monday that major US banks are well regulated, and that’s true. He announced that he would strengthen the rules so that the Silicon Valley bank scenario would not repeat itself. In truth, it is not difficult, it is enough to introduce liquidity requirements, regardless of the size of the bank. To avoid panic in the market, an exception has been made, all Silicon Valley Bank deposits will be returned. The real reason is they don’t want to stifle the tech startup ecosystem.

The bankruptcy of Silicon Valley Bank, in addition to mismanagement, also shows that innovation remains a risky sector. Should banks really finance innovation?

Ekaterina Lyubochinskaya: Innovation is always very risky to finance. In my opinion, the bulk of the funding should come from institutions that don’t have very short-term profit caps. In Europe, the European Investment Bank (EIB) has a long history of private equity and venture capital. The Banque Publique d’Investissement (BPI) in France does this too. However, these are financial institutions that do not have very short-term limits on profitability and are not listed on the markets. Since the markets tend to overreact, and when you finance risky sectors of activity, you should expect losses.