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Understanding the Silicon Valley Bank Failure

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In the wake of last week’s collapse of Silicon Valley Bank, BMO Equity Research financials team hosted a call with former FDIC Chair Sheila Bair. Our panel of experts discussed the fallout and what we can expect going forward. Listen to the replay.

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  • Sheila Bair, former Chair, FDIC

  • James Fotheringham, U.S. Financial Services Analyst, BMO Capital Markets

  • Sohrab Movahedi, Banks Analyst, BMO Capital Markets

The sudden demise of Silicon Valley Bank (SVB) and Signature Bank, the second and third largest bank failures respectively, after Washington Mutual in 2008, has sparked fears across the globe of a broader banking collapse. In a move reminiscent of the 2008 Financial Crisis, however, America’s Treasury Department, Federal Reserve (Fed) and the Federal Deposit Insurance Corporation (FDIC) intervened with emergency measures to shore up both banks.

To help break down what happened and discuss the potential impact SVB and Signature’s failures could have on the financial sector, BMO convened a panel of experts, including Sheila Bair, former FDIC Chair and two BMO Capital Markets analysts, James Fotheringham, U.S. Financial Services Analyst and Sohrab Movahedi, Banks Analyst.

No systemic issues in banking sector

It has certainty been an eventful few days. A week ago, nothing seemed out of the ordinary, and now two banks have closed, bringing down bank valuations across the board. Now banks face the rising prospect of costly policy responses from regulators. How did we get to this point? That was the first question Fotheringham posed to Bair.

Bair stressed that she felt the collapse of SVB was due to its unusual features rather than a systemic issue in the banking sector. “There are some unusual things about this bank,” she said. “It doesn’t suggest to me that it’s a reflection of any broader problems in the banking system.”

Fueled by ultra-low interest rates, SVB saw its uninsured deposits grow in recent years, with a high proportion of its clients’ deposits exceeding the $250,000 guaranteed by the FDIC. The bank also made several ill-advised investments in longer-term government backed and mortgage-backed bonds, taking on significant interest rate risk even as interest rates were going up. “The problem that SVB confronted, was with unmanaged interest rate risk on a portfolio of securities that lost market value because of rising interest rates,” she explained.

Treasury market risks exposed

Fotheringham wondered whether U.S. policymakers were right to step in. Bair was direct in her response, describing the move as an overreaction. If there was a broader issue, then the FDIC and others should get approval to put a wider backstop in place, she explained.

Although Bair questions whether the aggressive step was necessary, she said the new lending facility is ensuring the banks have access to liquidity without having to trigger mark-to-market losses on the securities, which has helped to calm nerves.

The aggressive increase in interest rates by the Fed has created challenges for the treasury market and mortgaged-backed securities, which are used to provide liquidity in the financial sector. “They are pretty much treated as zero to very low risk,” Bair explained. “But when interest rates rise, they are not.” She hopes this will spark a discussion about reassessing capital requirements for banks now that it’s clear there is risk in the Treasury market.

On the subject of interest rates, Bair said she thinks the Fed needs to stop and assess what the impact is, not just on the financial system, but the economy generally. “If we do go into deep recession, credit losses are going to go up significantly,” she said. “I think and hope that can and will be avoided.”

Future bailouts not guaranteed

Having guided the FDIC through the collapse of hundreds of banks during the financial crisis, Bair was sympathetic to the difficult decision to backstop these two banks to effectively insure deposits over the $250,000 FDIC threshold. Still, she worried that the backstop sets a dangerous precedent. “It creates all sorts of distortions and expectations that undermine the banks that are not beneficiaries of that special backstop for uninsured deposits,” she said.

By rushing to support the big banks, she said she was worried that policymakers risk creating the perception that depositors are more likely to receive FDIC protection if they are at a bigger bank. “If you create that market expectation, it's definitely going to hit the smaller banks,” she said. Even though Bair feels the regional and community banks are in good shape, she said that recent fears put more withdrawal pressure on regional banks because people were confused.

Still, Bair cautioned depositors from assuming the government would step in to cover deposits over $250,000. “We have deposit insurance limits for reason,” she said, although she notes that the limits could be raised for transaction accounts that are used for payroll and operational expenses.

Shifting the focus to the moral hazard of the intervention, Fotheringham asked Bair whether there is a difference between FDIC protecting Main Street households and transaction accounts versus the assets of venture capital firms.

Main Street doesn’t have the ability, time or acumen to review the financial statements from their bank, she explained, so they need assurance and peace of mind that they’re going to be protected no matter what. She had a different view of venture capital firms. “I certainly think ultra-rich venture capitalists should be expected to know what they're dealing with and what kind of risks that bank is taking,” she said.

Speed of collapse caught policymakers by surprise

The collapse of SVB and Signature took place over less than 1 week’s time:

  • March 8: SVB announced it planned to raise $2 billion to shore up its balance sheet after recording a $1.8 billion loss on the sale of securities.

  • March 9:  Worried about SVB’s financial position, the venture capital firms and tech start-ups that make up a large share of SVB depositors withdraw their funds. 

  • March 10: FDIC takes over SVB

  • March 12: Facing rising risk of a bank run Signature Bank, which accepting crypto deposits, is shuttered.

  • March 13: President Joe Biden announces new measures to protect depositors to limit fears of contagion to the rest of the financial system.

The speed of the collapse is what caught investor and deposit holders off guard. It came down to poor management and a lack of liquidity. “Banks fail because of a cancer in their loan book, but a heart attack in their treasury operations,” said Movahedi.

While nerves have been calmed for now, Movahedi wondered whether this latest crisis will lead to a wider conversation about higher insurance premiums and stricter regulations with tighter or harder liquidity and funding type constraints on the smaller banks.

In response, Bair said she expects short-term rising interest rates will increase deposit costs, although higher interest rates long term are good for traditional banks to take deposits and make loans. “I think there will be higher supervision that's not necessarily bad,” she added. “I think banks of all sizes appropriately need to be focused on liquidity. Examiners need to be too, and that can be thoughtfully constructed so it doesn't need to be punitive or harsh, but it certainly needs to be done.”

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James Fotheringham: Good afternoon everyone, and thank you for joining this afternoon’s conference call. I’m James Fotheringham, U.S. Financials Analyst at BMO Capital Markets in New York. I’m here with my great colleague, Sohrab Movahedi, who covers the Canadian banks for our Toronto office. Together, we are just delighted to have Sheila Bair here with us for a 45-minute discussion entitled Understanding the Silicon Valley Bank Failure.

As I’m sure you all know, Sheila Bair is a Former Chair of the U.S. Federal Deposit Insurance Corporation, better known as the FDIC, and a senior fellow at the Centre for Financial Stability. Sheila helped to shepherd the U.S. banking system through its darkest days during the Great Financial Crisis. Consequently, she maintains a very influential voice as it pertains to the development of bank regulation, especially during times of crisis.

It goes without saying that we are deeply appreciative for her being with us today to talk about what the heck happened over the past couple of days, the policy responses to what happened, and the eventual implications of those policy responses for banks in the United States, Canada, and beyond.

Sheila, thanks so much for giving us this time.


Sheila Bair: Well, thanks for having me.


James Fotheringham: Excellent. If it’s okay with you, let’s jump right into questions.


Sheila Bair: Okay.


James Fotheringham: Many thanks to all of you listening who submitted your questions earlier today.

Sheila, the past few days have featured U.S. bank runs, bank failures, the collapse of broader bank valuations, and costly policy responses for bank regulators. How did we get here? How did this happen?


Sheila Bair: Yes. Well, I do think that it is a bit of an overreaction here. I mean, Silicon Valley Bank was an unusual bank, a $2 billion bank, not insignificant, but in a $23 trillion banking industry, not something I would consider systemic at all. It had some unusual features. It had a very high reliance of uninsured deposits, it was very concentrated in kind of (inaudible) communities, these fees (phon) and their portfolio companies, they all talk to each other and listen to each other, and so word does spread pretty fast once some of them started pulling their uninsured deposits out.

It was rapid growth. It did not—it made ill-advised investments in longer-term government-backed bonds and mortgage-backed securities, and amazingly didn’t manage the interest rate risk, even though everybody knew interest rates were going up. I assume they thought they could hold them to maturity, and obviously couldn’t when the deposit growth (phon) started.

I think there’s some unusual things about this bank. It doesn’t suggest to me that it’s reflective of any broader problems in the banking system. I wrote a piece for FT this morning where I did take issue somewhat with the systemic risk designation for this at an even smaller bank, Signature, because it’s not clear to me. I think systemic risk determination should be really things that matter, throughout the system. It wasn’t at all clear to me that that was the case in the managements of these two failures.

If it was a broader problem, then they should really explore their fast track authority for the updated fee to get approval for a broader backstop, for uninsured accounts. That’s really what they should explore, not these kind of one-offs, and in my view, inappropriate use of systemic risk designation.


James Fotheringham: Yes.


Sheila Bair: It’s (multiple speakers), yes. I don’t think there’s broader problems with the economy, the banking system. I think this is an overreaction. Things seem to be calming down now; I think that’s really due to the Fed’s new lending facility where if you are holding a lot of securities that have lost market value because of rising interest rates, you can post (phon) them as collateral, get the full value, and then up to a one-year loan at a not bad interest rate.

I think the ability to access liquidity without having to take marks on these securities that otherwise have lost market value, I think the market’s taking some confidence in that, so that is helping.


James Fotheringham: Yes, we all saw your FT op-ed today, perfectly timed. Thank you for that. We’d encourage anyone who didn’t see it…


Sheila Bair:Oh, (multiple speakers).


James Fotheringham: To take a look at it at I totally understand and respect your view. In terms of the responses to the events, just to detail it and go through some of the things you said, the U.S. government has assured all deposits at the banks that failed, it introduced this new liquidity facility that you referenced that’s now available to all banks, and it provided a blanket commitment to address any further liquidity problems.

Now, what I want to know is, is that enough to stem the bank runs, and what do you think would have happened if none of these policy responses had been taken?


Sheila Bair: Right. I’m not sure. I think it’s not clear to me that we would have had a problem. I think it’s unfortunate that the FDIC wasn’t brought in earlier to be able to market this bank and sell it before they had to close it. That was the procedure we used in the vast majority of failures that we—about 400 that we handled under my tenure. It was rushed, they didn’t have a chance to do that, and so they had to react quickly, and I understand positions (phon) can be tough in that timeframe.

But these were not systemic banks. There was no need to—the uninsured deposits, I can’t believe that anybody would think, unless there’s something really, really wrong with their banking system, and I don’t think there is, why the uninsured depositors at two mid-sized banks couldn’t take a 10 percent, 15 percent, probably at most, haircut of their uninsured deposits, that we had to use this extraordinary procedure.

I think the liquidity facility, it did do a lot to staunch any kind of jitters around other banks that might be confronting this unique—well, not a unique problem, but the problem that SVB confronted, with unmanaged interest rate risk on a portfolio of securities. They’ve lost market value because of rising interest rates.

But I saw some private analysts who had been looking through those, and even the number of banks that are in that situation was not a great number, and here again, the liquidity facility is going to be helping them out. I’m mixed on that. That’s providing system stability that (inaudible) at BMO, unless the other banks listening here have been managing their interest rate risk, so good for you in taking marks when you should, good for you. We’re going to be bailing out the other three yet. But for overall stability purposes, it’s probably a good thing that (inaudible) that facility.


Sohrab Movahedi: You’ve made it clear, Sheila, that in your opinion, the systemic provisions probably shouldn’t have—they didn’t apply here. I guess…


Sohrab Movahedi: Can you just talk a little bit about, why would the regulators have overstepped, I guess, in your opinion? What could they have done differently, and if there are any unintended consequences that you can think about…


Sheila Bair: Mm-hmm.


Sohrab Movahedi: From this policy response?


Sheila Bair: Well, they did. I think that the Fed facility probably was much more effective, I think, in staunching deposit, withdrawals.

Doing a systemic risk determination for two banks doesn’t really help the other banks, and I think the early response to this was actually we saw even more deposit withdrawal pressure on some of the regional banks in the U.S. Because people were confused, they were, “What’s a systemic risk? What else is going on here?”


Again, it’s, I think, just an orderly—following their usual procedures, announcing an advanced dividend for the uninsured deposits, which is what we always did when we couldn’t—once when we could sell them, but once when we didn’t, we did an immediate dividend at some percentage of the uninsured where we were confident we would have recoveries to cover that, which helped tide over the uninsured with their cash needs.

I think following the FDIC’s normal procedures, perhaps some buying of the amounts in this facility would’ve been fine. But you set a dangerous precedent here, a systemic risk to—is everybody $100 billion and above systemic now? Then, what happens to the community banks? Is it, billion dollar banks are systemic, what about their uninsured deposits?

These one-off bailouts for individual institutions create all sorts of distortions in expectations that I think potentially undermine the banks that are beneficiaries of that special backstop of uninsured deposits. But it also creates—could impact market discipline and make banks be even more relaxed. If you’re a loosely-managed bank already, oh, well, the FDIC’s going to bail me out, it’s going to be one or the other. It’s going to be uncertainty or an assumption as a bailout. That’s what we saw with the Lehman Brothers situation when Bear Stearns was bailed out so early.

Again, I think the systemic risk determination in not following the rules and giving certain banks special deals, because supposedly they’re systemic, I think that’s a terribly dangerous precedent. I know, I can only assume—this is not a decision by FDIC, with the FDIC, the Treasury, the secretary and the President all coming together, which kind of underscores why this is only supposed to be used in extraordinary circumstances.

But I’m scratching my head. I don’t think it was necessary, I hope we don’t see any more of this. But again, they’ve set up the expectation which is going to create even more pressure to do bailouts later on.


James Fotheringham: Just following that logic, now that assurance has been made to all depositors at SVB and Signature Bank, do you now consider U.S. bank deposits across the system as essentially insured? That is, should we take it as a given that other bank failures that may or may not…


Sheila Bair: No.


James Fotheringham: Come will have the same FDIC…


Sheila Bair: No.


James Fotheringham: Insurance guarantee as the two that failed?


Sheila Bair: No, I don’t take it as a given at all. They’ve got to go—no, they didn’t do that. They gave two banks the special deal, and to do any—if they think we’re going to continue to have uninsured deposit loans, and maybe we won’t. This Fed facility may be enough. I’m hoping and praying it will be enough to stabilize it—but if they think uninsured deposit runs, as opposed to individual banks, but uninsured deposit runs are a systemic risk, there is a fast track procedure. They can go to Congress, get approval to provide a broad temporary backstop for uninsured accounts, at least for transaction accounts, and I think that’s what they should do.

No, there’s no guarantee. If that’s the perception they were trying to create, I don’t know if that’s the case at all. I don’t think the markets or depositors, that that was the case this morning. Again, I think the Fed facility was what calmed things down.

These are one-off. You’ve got to get—just to be clear, any other banks that think they’re going to get the special deal, you’ve got to get two-thirds of the FDIC, two-thirds of the Fed, the Treasury Secretary and the President to all agree that your uninsured depositors need to be bailed out. There’s no guarantee that’s going to happen, anymore, or for all banks, and I don’t think it will.

Again, what about—are you going to do it for a $5 billion bank, a $10 billion bank, a $500 million bank? There may be small banks that have issues with uninsured deposit withdrawals. I think it was hard enough to do it for a $200 billion and $100 billion bank to make a systemic determination.

No, there’s no guarantee, if people have that perception, I don’t think it’s accurate. Again, the Fed facility’s there for liquidity now, if you’ve got a lot of unmarked losses on your securities, you can post them and get a fully collateralized loan without haircut. That helps. That will help liquidity.

But no, I think people would be ill-advised to think that everybody’s going to get bailed out now, one by one by one, with the systemic risk determination. I don’t think that’s realistic.


Sohrab Movahedi: Sheila, you’ve mentioned, I think, several times about the effectiveness and the relevance of the bank term funding program. A bit of a cynical question, I guess; is there going to be a stigma associated with banks that end up using…


Sheila Bair: Yes.


Sohrab Movahedi: (Inaudible)? Should there be stigma, and what’s your…


Sheila Bair: Well, I…


Sohrab Movahedi: (Multiple speakers) on what do you think will be required to be provided?



Sheila Bair: No. Well, that’s a good question, and probably your view on that will depend on whether you think you’re going to have to use it or not, right? I think the banks that won’t have to use it, they should wear that as a badge of honour, that’s just they’ve really managed their interest rate risk well. If they do have to use it, well, so be it, maybe that’s the—we just do that and look the other way for system stability.

I don’t know, I think that’s a really tough question. I would say at a minimum—and I said this in my op-ed and I’ve been saying it all day, at a minimum, the Fed and other bank examiners should go in there and examine if these banks, with large amounts of unmarked—because if they can hold a maturity, they’re an AFS too. If they’re a smaller bank, they don’t have to mark those. The securities that have lost value, that have not yet been marked for accounting purposes, if they had to sell those, and on an emergency basis, would they have the capital to absorb it?

If they don’t, then have some good conversations with them about increasing their capital or taking other corrective steps. A minimum, and that can be part of a confidential supervisory process, but at a minimum, I think bank regulators should do that.

I’ll tell you what, I’ll dodge it and defer to the Fed about what kind of public disclosure they want to make around usage of the facility.


James Fotheringham: Fair enough.

Can we sort of move the topic to moral hazard? The financial system has been bailed out now a few times in recent memory—GFC, pandemic, and now this liquidity crisis. When it comes to bank deposits in particular, where do you think personal responsibility starts, and where do you think personal responsibility stops, with respect to moral hazard?


Sheila Bair: Yes. Yes. Well, we have deposit insurance limits for a reason. There’s some people who don’t like deposit insurance at all, maybe because of the moral hazard, I don’t buy that. I think for households, regular, main street (phon) households, they don’t have the ability or the time, or the acumen, to be going in there and looking at banks’ financial statements and things, we need to give them some assurance and peace of mind that they’re going to be protected no matter what.

That’s still how we calibrate the insured deposit limits, to protect those main street households. Even in some wealthy ones too, I might add, because there are a lot of different ways in terms of how you structure your accounts to get way more than $250,000, and of course they have these deposit exchange programs where, even community banks can offer a lot more. There are a lot of ways where you can get more coverage in that already.

But I do think you need some market discipline, and I certainly think ultra-rich venture capitalists should be expected to know what kind of bank they’re dealing with and what kind of risk that bank is taking, and not then all of a sudden close the bank. Which, it might have—it was mismanaged, but I think it still had some good assets and a really valuable franchise. If it hadn’t had been for the deposit limit, think they could’ve made it. It was somewhat self-destructive.

But I do think there should be deposit insurance limits. I think there is an argument for unlimited, or at least higher limits on transaction accounts, because, with transaction accounts, we saw this during the crisis, of community banks in particular. They were losing their business accounts, their institutional accounts that were used for payroll and operational expenses. They have to go about their insured deposit, and that’s right (phon), $250,000 is going to give you enough liquidity to manage your cash flow needs if you’ve got a business organization of any size.

The community banks were losing those deposits during the crisis to bigger banks, and we instituted something called a temporary transaction account guarantee, and so temporary approving. We provided unlimited insurance to transaction accounts that have not yielded insurance (phon) that were just used for payment processing. It worked; it stabilized the deposits in the community banks and worked very well. Much to my surprise, and the Congress, I’ll be honest with you, I think this is through lobbying of the money market industry, and if any of you are listening, you tell me and shame on you if you’re involved.

But anyway, Congress ordered the FDIC to not (inaudible) like that anymore without Congressional authorization, but they provided a streamline procedure for it, as I said earlier. I think that’s something, if we see run pickups, deposit runs accelerate, that’s really something the FDIC should do. I think if Treasury and the President, and the Fed supported them, I can only imagine that Congress would be able to give them that authority pretty quickly.

A temporary liquidity program like that, the flexibility to institute something system-wide I think makes sense. I regret that the Congress took it away from the FDIC to begin with. It can be a larger debate about whether we should just lift, at least for transaction accounts, lift deposit limits. I believe Japan does provide unlimited insurance for their transaction accounts. (Inaudible) years ago when I was over there and discussing this issue with—sorry, I think it’s a conversation to have, and who knows, maybe this instance will help reciprocate that.


Sohrab Movahedi: Sheila, just as we think about the insured, uninsured deposit, I guess, cap, what about just the mix of uninsured deposits as the funding profile—as part of the funding base of the banks? Should there be a cap on the proportion of uninsured…


Sheila Bair: Yes.


Sohrab Movahedi: Deposits, let’s say as a percentage of total deposits, or at least for the banks that are part of the FDIC coverage?



Sheila Bair: Yes. Mm-hmm. Yes, well, I think runnable (phon) liabilities are something generally that I believe the FDIC looks at in setting its risk-based premiums. But maybe more, I think the change, the adjustment in premiums is not great, maybe that would be one way to do it, to just charge very, very high premiums for banks that have what I’ll call runnable liabilities. Even retail, even insured can run if it’s all just based on yield, and we certainly saw that with these rapid growth banks during the Great Financial Crisis.

They were fairly new banks and they’d just gotten broker deposits and levered up on commercial real estate. That turned ugly pretty fast, so maybe we should think more about runnable liabilities. But that is already factored into deposit insurance premiums, I believe, that maybe should be more explicitly so.

Yes, I think the percentage of—uninsured deposits by themselves are not bad, they’re good. I mean, businesses with large accounts need bank accounts too, you want to attract that business. But maybe some thought about putting some standards around the mix is a good idea. Or at least, do more to adjust premiums for deposit insurance.


James Fotheringham: You mention deposit exchanges in this regard. Can you just explain a little bit more how you think these deposit networks, like IntraFi, can play a role…


Sheila Bair: Yes.


James Fotheringham: In distributing deposits among banks according to these insurance limits?


Sheila Bair: Right. Well, to be honest, I’ve never been a fan of those. I’m glad that they provide—they help make the smaller banks more competitive with the bigger, (inaudible) to fail banks. But it’s a bit of a free ride on the FDIC, the deposit insurance fund. For that reason, I’m troubled by it.

I think if we’re going to have those programs, that frankly, they should be paying a fee to the FDIC too, because it really is just a free ride on the deposit guarantees with the government, and actually the banking system provides, or the banking system capitalizes the deposit insurance fund.

But they’re here, they’re here to stay, I don’t think they’re going anywhere. I mean, ironically, if we did want to raise deposit insurance caps, and that would probably kill that industry off, that’s something to think of as well. But I guess I can live them, but I do think they should pay something to the FDIC because it’s pretty much a free ride.


James Fotheringham: Understood. How do you feel about the current capital treatment for securities held on banks’ balance sheets? Now that…


Sheila Bair: Yes.


James Fotheringham: Interest rates have moved higher, some regional banks have implied marks on their held maturities, securities portfolios, in excess of tangible common equity. This must be a problem. I mean, should there be a change to the capital policy as it relates to…


Sheila Bair: Yes.


James Fotheringham: Market to market bond portfolios, and/or the treatment of AOCI and regulatory capital? Similarly, do you think the solvency risk implied by these securities books, as evidenced by the recent bank failures, are adequately considered in RDB ways in terms of their current asset risk weightings?


Sheila Bair: Yes, oh, there’s a lot to unpack. A lot to unpack in that...


James Fotheringham: Yes.


Sheila Bair: (Inaudible). I think securities that are in AFS should be marked, period, full stop. I think with holds and maturity, I think maybe not, because these are somewhat unusual times. I mean, that the Fed’s increased interest rates from 0.08 percent at the beginning, to what is it, just north of 4.5 percent now. I’ve figured it out, it’s about a 6,000 percent increase.

This is extremely rapid—4.5 percent by itself doesn’t sound high, but in relation to where they started, this has been highly aggressive. I think we are in unusual times, making this more of an issue than it ordinarily would be.

Certainly anything in AFS should be marked. HTM, I can debate it both ways, but if they don’t make the market, then it’s part of the supervisory process. At least, examiners should be looking to see, if they had to sell them, what would the head of capital be?

I also say that, just generally, the regulatory incentives that regulators give banks to buy government-backed securities are pretty powerful. There’s zero risk weight on Treasuries, pretty low on GSE-backed mods and MBS. There’s very favourable treatment on the liquidity rules. They’re pretty much treated at zero to very low risk, when really, when interest rates rise, they are not. They are not.

Perhaps reassessing the capital requirements; certainly, what I do hope, and apology if some of you have pushed for this, but there’s been a big effort by bank lobbies in the U.S. to get Treasury securities out of the denominator of the leverage ratio. I have fought that for years, and continue to oppose it, and I hope now at least what’s going on here with market losses on Treasuries will help people understand, there is risk in these as well. Providing even more powerful incentives to load up on Treasury securities, which you would do if there were no capital requirements at all, banks could use 100 percent leverage to buy them. Then, you’re really going to see banks piling into that asset class even more, which I don’t think is good from a safety and standard (phon) standpoint.

I don’t think it’s good from the standpoint of making sure—you want banks to take some risk, right? If you want to enjoy them, you want to invest in other instruments that help support the real economy. You just don’t want everybody piling into government. Yes, I think there’s…


James Fotheringham: That’s a great—yes.


Sheila Bair: (Multiple speakers). Please, go ahead.


James Fotheringham: No, I didn’t want to—you go. I didn’t mean to cut you off, sorry.


Sheila Bair: Well, no, I just think that that might be some silver linings coming out of this, and this may be one, to just reassess the regulatory treatment of government debt. Is it favoured too much over private sector credit provision, which I think it probably is.


James Fotheringham: Really good point on leverage, I just wanted to catch you up on the AOCI question. The option for non-systemic banks to include it or not in regulatory capital, do you think that…


Sheila Bair: Right.


James Fotheringham: Option should be clawed back?


Sheila Bair: Eliminated? Yes. Yes, I think that should be eliminated, yes.


Sohrab Movahedi: Maybe it’s a good time to kind of just now move to a different topic, think about the near and longer-term kind of implications. I guess the question I want to ask is, what happens next? The big banks just keep getting bigger? Is there going to be higher insurance premia, stricter regulation, is that going to be punishing for the smaller banks…



Sheila Bair: Yes. Yes.


Sohrab Movahedi:Disproportionately? Would all of this mean more bank mergers maybe in the U.S. banking system, more consolidation? After what we’ve kind of…


Sheila Bair: Yes.


Sohrab Movahedi: Seen over the last number of days, does anyone want to put any money in small banks? When the big banks basically offer the same…


Sheila Bair: Well, no. No, it’s really…


Sohrab Movahedi: Yes.


Sheila Bair: Bailouts encourage big banks to get bigger, because the bigger you are—you were bailed out before, you’re propped up, and you have (inaudible) of perception which is what the largest banks in the U.S. enjoy now. Again, with what’s going on now, I’m just wondering, so are we loaned out to $100 billion, anybody over $100 billion now? Is that going to be the market expectation, that those are going to be designated systemic and their uninsured are going to be protected?

If you create that market expectation, it’s definitely going to hit the smaller banks. I mean, why would anybody keep uninsured money with them if they have reason to believe that the FDIC’s always going to protect the uninsured and the larger banks? Which is why I think, I don’t like bailouts period, but if you need to do them, do them for everybody. Because if you don’t, if you pick and choose, you’re going to be distorting depositor behaviour, you’re going to be punishing healthy banks that didn’t do anything wrong.

Yes. I mean, I think that’s—don’t do bailouts. If you have to do it, do it for everybody. Just don’t choose institutions or certain-sized institutions to help.


James Fotheringham: Well, these bailouts, broad or narrow, cost the banking sector. I’m just wondering if you could detail, what are the expected costs—what are the social dividends, if you will, to be…


Sheila Bair: Yes, yes.



James Fotheringham: Made by banks as a result of this latest bailout, in terms of…


Sheila Bair: Yes.


James Fotheringham: I’m thinking about higher insurance premiums. I’m thinking about stricter liquidity requirements, certainly higher capital requirements, eventually. Then…


Sheila Bair: Right.


James Fotheringham: If you could also just—if there’s a cost to banks from this, what proportion would you expect to be passed on to bank customers versus bank shareholders?


Sheila Bair: Yes. Well, I get concerned about that too, and it’s back to, it’s just an unusual kind of, a handful of banks with these types of characteristics, or is this a broader problem? If it’s just a matter of bad interest rate risk management by a handful of banks, bringing down the hammer on everybody, I think, is—and I think it is frankly, bringing down the hammer on everybody is just not really going to be productive.

But this gets back to the question, well, this is systemic, right? We’ve got to go after everybody. If this is all regulation, that the mid-sized banks have got to re-regulate them again, then I think there’s going to be some—yes, I think there’s going to be some significant increase in regulatory costs, and I hope that doesn’t happen. Because from what I can tell now, I’m learning every day like everybody else, but what I can tell now, the regional banks and the community banks are in pretty good shape.

Regulation has worked, and also pile on rules on banks when maybe examiners missed something, or in bank management. There’s got to be some personal accountability. Sometimes people just make mistakes, and we all make mistakes, and we hope we will hold ourselves accountable and correct our mistakes that for human error if you will, lapses in judgment or whatever or oversight, to use that as the catalyst for a whole new layer of regulation, that’s not a great idea. It would be a very, very bad outcome. We talked about some discrete areas. The capital treatment of unrealized losses is one, so there are some discrete areas where I think we could improve regulation.

But overall, I think the system is, and for the smaller banks and the regional banks, I think it’s fine. Before this, I was learning way more about the non-banks (audio interference) and their interrelationships with the largest banks. There’s not a lot of transparency there; we know these funds—these private funds, use a lot of leverage. Nobody’s quite sure what the exposures are. Somebody asked me earlier at another session, “What’s the next shoe to drop?” I hope there are no next shoes to drop, but if there were, I’d be looking at the nonbank sector because certainly, they are dramatically (audio interference) by the Fed’s rapid increases in interest rates, and who knows how they may have been papering over that for now? Because, there’s just not a lot of transparency around them.

But yes, I think that’s a real danger and I think it’s important for people to be aware of. I’ve been trying to tell people since I started, I have certainly—my confidence in the regional bank sector, I think traditional regional banks performed very well during the Financial Crisis, they’re performing well now. They’re pretty much currently well-managed, they’ve got diversified deposit bases. A lot of—heavily reliant on core deposits. There really isn’t something—there’s no broad-based problem that depositors should be aware of when it comes to regional banks.


Sohrab Movahedi: Sheila, we obviously have clients on the line and present kind of beyond the borders of the U.S. Many of us, I as a Canadian bank analyst, we would always kind of think about, well, what are some of the potential ripple effects of this beyond…


Sheila Bair: Right. Right.


Sohrab Movahedi: The U.S., I guess, regional banking space. What sort of stuff do you think we should be thinking about, worrying about?


Sheila Bair:Yes. Well, we’ve talked to—I mean, there are political risks, there’s kind of a backlash risk from all of this, is going to be (audio interference). I think, look, interest rates generally—interest rates still go up as trades go down. Independent of any drama around SVB and Signature, obviously deposit costs are going to go up. (Inaudible) is getting more competitive for money out there as you have to start paying more interest on—all banks are going to have to start paying more interest on their deposits. That’s going to compress that interest margin.

We may well have a recession coming. I hope we don’t. I have said, since last September I said the Fed should hit pause on their interest rate increases because it’s just been—they’ve done it so quickly and so dramatically. They really need to take a deep breath and assess, what’s the impact? It’s not just on the financial system, but the economy generally.

There is that. If we do go into deep recession, obviously your credit losses are going to go up significantly. I think and hope that can and will be avoided. That’s certainly something that, in terms of your forward thinking of banks and those who analyze banks, how resilient are they in that kind of a scenario?

That said, I mean, higher interest rates long-term are good, for traditional banks that take deposits and make loans. This era of (audio interference) money, it was really, really hard to get a decent return on your lending. Meanwhile, if you’re an investment bank with large securities portfolios, you are fat and happy. You got a lot of corporate debt issuance and the equated (phon), the financial assets you held were going up in value. That was a good ride, but it’s unwinding now.


But for traditional banking, it’s better to have high interest rates. Your margins are better, capital allocation’s more disciplined. If you get some decent return on your loan that, yes, you could take a little more risk with some loans and take a little more risk, for small business or whatever, it’s not necessarily a bad thing if it’s done right.

Yes, I think short-term, rising interest rates are certainly going to impact increased deposit costs. That’s something for everybody to be aware of, and the risk of recession is also something to make sure you’re prepared for.

But I do think if the Fed hits pause, assesses, take a breather, lets—I mean, housing inflation has been such a big component of these numbers, and there’s a lag, as you all know, and when the housing corrects and gets into the inflation data. I think that’s another reason why (inaudible) hit pause. If they wanted to tighten further, instead of raising short-term rates, I guess, if housing doesn’t cool off, they could sell some of their mortgage-backed securities. That would at least be targeted to the housing sector.

Certainly, it would hit MBS valuations even more. But now that the Fed has this facility where you can bring those securities and borrow them for full value, maybe that’s less of an issue. I mean, just hypothetically down the road, if housing inflation has been coming down, that would be another option they would have, without raising short-term rates, which really is putting such pressure on the yield curve and presents much greater risk.

Well, it hits the entire economy. It hits credit cost everywhere, and particularly increases recession risk because of the inverted yield curve. This imperils labour markets.

Hopefully they can hit pause and let this flow through, and we can see if it continues to cause less than inflation, then it’ll be good. But if not, I really wish they would think about some sort of support (inaudible) keeping on raising short-term rates.


James Fotheringham: Last I checked, no buyers have emerged yet for the banks that have failed.

Why do you think that is?


Sheila Bair: That’s troubling in itself. I don’t know, that is troubling in itself. I don’t know, I don’t have any sight into that. I don’t know, and I’m not even going to speculate.

It’s surprising, because we had—those franchises that would seem could be—well, okay. I won’t speculate, but I will make an observation.

There were, under the Obama Administration Justice Department, there were some losses brought against banks that had bought sales banks from us, basically holding them responsible for the bad conduct of the banks that they had acquired. I disagreed with that then, I disagree with it now. I’ve publicly criticized it. I said then and I’ll say now that that does nothing but to give bank bidders a dis-incentive to buy sales banks.


If that (inaudible), and I don’t know. I don’t know if that’s a factor. It’d probably be good for this Administration to announce that you’re going to put it in paperwork too for the acquisition, that you’ll be held harmless against any civil or criminal liability associated with the bad conduct of the bank management that you’ve just acquired.

It may be—some of the drama it’s got people skittish to around all of this, I think these things generally went more smoothly when you were doing them quietly, and then just announce the transaction. That might be scaring people off too, I don’t know. It’s hard to tell, but I hope this is not an indication that people are going to be reluctant to buy.

I do think that private equity has a role here. We allowed private equity to acquire banks—well, to acquire the whole bank, you have to have a bank to acquire a bank. If they formed, they got a banking charter and got approval from their primary regulator—most of them got national charters—we allowed them to bid on failed banks, and then we put some special rules around it, lock-up periods and higher capital requirements for a certain period of years, just because they didn’t have a track record. That worked pretty well.

But I do think private equity’s got a role in this, because they’re distressed asset buyers. These are viewed as distressed institutions; they are somewhat, even though I think they’ve got a pretty good book of assets. You need to let them come in and compete too, and there are ways you can put (inaudible) around that to make sure that the FDIC is dealing with responsible buyers.


Sohrab Movahedi: Sheila, one of our clients over the weekend reminded me, he said that we know banks die of cancer in their loan book, but it’s a heart attack…


Sheila Bair: Yes.


Sohrab Movahedi: In their Treasury operations.


Sheila Bair: That’s exactly right.


Sohrab Movahedi: It clearly was that, and here. You’ve talked about some of the changes that have to come through. Just curious, obviously there were learnings that were had out of the Global Financial Crisis, but there was a decision to apply those different degrees of strictness, depending on the size of the institution.


Sheila Bair: Right.

Sohrab Movahedi: Two questions, I suppose. Are we going to see tighter or harder liquidity and funding type constraints on the smaller banks that were not bound by the NSFR and LCR type stuff that came through?


Sheila Bair: Right.


Sohrab Movahedi: Then, is there a chance that globally, systemically important ones, the larger ones, may also just, as a result of this, for whatever reason receive higher supervision as well?


Sheila Bair: Well, I think there will be higher supervision, that’s not necessarily bad. I mean, obviously examiners and managers of all sizes of banks need to be hyper-focused on the liquidity right now, given just what’s been going on.

Again, not all small banks are virtuous, not all mid-sized or large banks are virtuous, but the traditional community bank is going to have that slope, they’re going to have the loan book. They’re not going to have huge securities portfolios. Maybe some of them have now—now, I will have to admit, they (inaudible)—I mean, there’s just so much money in the system that the Treasury securities have for all banks side, those holdings have gone up quite a bit.

But there again, you’ve got this debt facility now to help them access liquidity, they’re going to need it. I think it’ll be okay. I think we’ll be okay, but I think banks of all sizes, appropriately, need to be focused on liquidity, and examiners need to be too. That can be thoughtful and constructive, it doesn’t need to be punitive or harsh, but it certainly needs to happen.


James Fotheringham: Among the financial systems globally, there appears to be an inverse relationship between competition and stability. Inarguably, the U.S. banking system with its 5,000 banks is more competitive than its international peers.


Sheila Bair: Right.


James Fotheringham: Does that mean that it is also inherently less stable? Are these U.S. bank failures just now a fact of life, or should the regulator push for consolidation to become more stable as a system?


Sheila Bair: Yes, well, that’s more the Canadian system, and I can argue about why the Canadian system is very stable, and you’ve never had a major bank in crisis. The U.S. banks will tell you that the Canadian banks (inaudible) all of innovators, the U.S., that’s what they say, that’s not what I say. I think that the truth is probably somewhere else.

It’s a trade-off. I do think a principles-based approach. I do think that regulation is too prescriptive, too rules-based. It’s inflexible, it’s not dynamic. It can’t respond to changing conditions and risks the way more principles-based framework does.

I will also say that I think—I haven’t done a lot with Canadian banking regulators, I worked with them a lot during the Financial Crisis and on the (inaudible) Committee, and know some of them and know people who work with them. But just my sense is, and maybe it’s because you have a concentrated banking system—you don’t have to go through the formalities of rule-making and etc. I mean, if you’ve got a concern, the bank supervisor or the regulator in Canada has a concern, they pick up the phone and call the bank and work it out.

That’s the way it used to work in Paul Volcker’s day. I think now, for whatever reason bank regulators don’t feel empowered to do that so much. If you think a bank needs no capital, you got to do rule-making for everybody or put out guides or something, pick up the phone and call them. But my sense is you had more of that ongoing dialogue between meeting regulators in the banks that we don’t see this in an ongoing interaction as before.

But I think there are real strengths in our banking system. I like the fact you don’t have community banks, I like the fact you have community banks. I bank with a community bank. I also have an account with a large bank, because for wires and some things, community banks aren’t able to provide the same level of service. But I think that diversity of choice for people in the U.S. is important. But yes, that means it’s harder to supervise them, harder to regulate them, and we have more bank failures.

But banks fail. I just wish—it seems like we had such the strong education efforts with the FDIC about deposit insurance and protections, but people just always seem to be surprised when (audio interference), I’m not sure why, for a bank of any size. But it happens, and you need it, if you want any kind of market discipline to complement regulation, you need the possibility of bank failures. Regrettably, I think we’ve lost a lot of that with our biggest institutions now.


Sohrab Movahedi: Look, it’s 3:15. We’ve come up against our time. We want to be respectful of your time and the participants. Sheila, thank you so much for sharing some of your insights and maybe reassuring thoughts on the current situation.

For those of you who don’t know, Sheila is also an author of a children’s book teaching personal finance…


Sheila Bair: Thanks for the plug.


Sohrab Movahedi: To young readers. I know that…

Rock, Brock, and Saving Shock, that’s been a hit in the Fotheringham household, and I know I can’t wait to see how this latest crisis features in the next book.

Look, a big thank you…

Sohrab Movahedi: To our clients for participating on today’s call…

All of us at BMO Capital Markets, especially James and I, appreciate your business and trust in involving us in your process. Thank you everyone.

That said, that’s a wrap.

Sheila Bair: Thank you for having me. Bye-bye now.

James Fotheringham US Financial Services Analyst, BMO Capital Markets Corp.
Sohrab Movahedi Banks Analyst, BMO Nesbitt Burns Inc.

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