Some Key Lessons We Learned from Recent Bank Turmoil in the US

In March，liquidity runs rattled the US financial sector，resulting in the failure of several regional banks，including Silicon Valley Bank (SVB) and others.

The turbulence caused market disruptions，fears，and significant deposit withdrawals from small and medium-sized banks. The US banking regulators took it seriously and acted swiftly to preserve the banks by introducing a new Bank Term Funding scheme that permits them to borrow at par against secured treasury and agency securities for up to one year. In the interim，they offer alternative funding options，such as discount window loans，among others.

Thus，a more calamitous financial disaster and additional domino effects were significantly averted. The Fed，FDIC，and other regulatory agencies collaborated in the following ways to resolve the liquidity run issue:

By expanding its balance sheet，the Federal Reserve guaranteed all SVB deposits，insured and uninsured，and injects significant liquidity into the economy via a variety of channels. Numerous public documents，such as congressional hearings，explained how the SVB failed. The Fed's rapid increase in interest rates，the bank's severe mismatch between asset and liability maturities，and the bank’s mismanagement of the relevant risks，along with its sudden massive loss of concentrated deposit clients，including venture capital firms and startups，were cited as the primary causes of SVB's failure.

Specifically，firstly SVB's long-term investments in Treasuries and MBS resulted in significant unrealized losses as interest rates rose. Secondly a massive run on deposit from VC and startup customers hit SVB unexpectedly，while the bank failed to raise sufficient capital in time. Thirdly the realized losses eventually accelerated the uninsured deposit run and triggered a formidable liquidity crunch. Fourthly SVB was compelled to cease due to insufficient funds and collateral to pay depositors on the same day.

This banking sector turmoil was a classic bank run not seen since the 1980s，when Continental Illinois went insolvent. It was precipitated by the Fed's unremitting rate-hiking cycle，bank mismanagement，and a loss of confidence in its funding ecosystem，as opposed to the credit crunches that typically characterize this stage of the business cycle. Inappropriate management of interest rate and liquidity risk lead to financial catastrophe! Even though SVB's case is unique and stands on its own，specific lessons can be derived from a variety of critical perspectives:

First Lesson: It suffered from a double whammy of inadequate internal risk management and lax external regulations. SVB operated without a Chief Risk Officer (CRO) for more than half a year，despite taking advantage of reduced regulatory requirements as a technology or regionally focused niche bank. The Economic Growth，Regulatory Relief，and Consumer Protection Act，which was passed in 2018，significantly deregulated local and regional lenders in order to reduce regulatory costs and burdens. In addition，the new regulations increased the threshold for "systemically important" assets from US$50 billion to US$250 billion. Such as SVB，banks with less than US$250 billion in assets were exempt from the full annual stress test requirement，the liquidity coverage ratio，and other prudential regulations that apply to the most systemically significant banks. However，SVB expanded significantly to become one of the most important participants in the Silicon Valley ecosystem，and the 16th largest bank in the United States with US$220 billion in assets despite failing to meet the threshold for stress testing.

With a shaky risk management governance and risk control structure traversing an increasingly volatile and perilous macro world，the question was not whether SVB would confront significant challenges，but when.

Second Lesson: It took unreasonable risks. During normal operations，each bank should tolerate a reasonable amount of liquidity and interest rate risk，but not an excessive amount，particularly as the banking industry experiences a dramatic interest rate hiking cycle.

The present Fed rate hike cycle is one of the most vicious in history by any measure. Before SVB's collapse，the Fed raised interest rates by 500 basis points in just one year. SVB aggregated deposits and invested in long-duration assets，exposing itself to the risk of undervaluing these investment portfolios and incurring enormous unrealized losses. Specifically，the bank attempted to raise US$2.25 billion in capital to replace a US$1.8 billion hole created by a US$21 billion bond loss.

In fact，SVB was not alone during this massive and rapid rate hiking cycle. The US banks reported unrealized losses of US$2.2 trillion. Nonetheless，the fashion in which banks manage their assets and liabilities has resulted in enormous disparities. According to the testimony of Michael Barr，Vice Chair of the Fed，by the end of 2021，Fed examiners had discovered six supervisory findings regarding the bank's liquidity stress testing，contingency financing，and liquidity risk management. Fed examiners also reported three findings in 2022 concerning ineffective board supervision，risk management deficiencies，and the bank's internal audit function. Fed also downgraded the bank's management rating to "fair" and rated the bank's enterprise-wide governance and controls as "deficient-1." The Fed examiners also expressed their concerns to the senior management of the bank.

In contrast，the most recent quarterly earnings reports of the four largest US banks demonstrated that remarkable asset/liability management enables them to withstand the rate cycle quite well and，more significantly，to outperform revenue and profit projections.

Third Lesson: The liquidity stress testing is relevant. Any bank must plan for specific liquidity risk scenarios and be completely prepared for sudden，significant deposit runs. Banks must und