The sudden collapse of Silicon Valley Bank was met by an equally swift response from US regulators. But the crisis is far from over, and the nature of the authorities’ response introduces problems of its own….. time inconsistency in policy making (coming up with new tools and rules after the fact) does present a difficult problem. In this case, a bank run suddenly rendered an optimal policy – limited deposit guarantees – suboptimal. But by breaking their own rule, regulators jeopardize their own credibility. Rescuing all SVB depositors – including those with deposits above the FDIC ceiling – is not without controversy, says Takatoshi Ito, a former Japanese deputy vice minister of finance, a professor at the School of International and Public Affairs at Columbia University and a senior professor at the National Graduate Institute for Policy Studies in Tokyo.
However, there are ways to mitigate moral hazard. First, depositors should be guaranteed for their principal, but not for interest payments (or at least for above-average payments). Second, bank executives’ salaries for the period leading up to the crisis – say, the previous three years – should be clawed back, and any pending bonuses should be denied. One reason why the 2008 bank bailouts were so unpopular was that executives still received bonuses. This must not be repeated in the current crisis.
In a piece with Project Syndicate, An Insolvency Iceberg, Ito detail analyze the logic, assuming the media’s reporting tells the whole story:
This is where moral hazard comes in. Now that US authorities have issued an ex post blanket guarantee, all depositors will expect that any and all deposits will be protected. They will duly pour deposits into institutions offering higher interest rates; but such competitive rates tend to be offered on large deposits by weak banks with tight liquidity constraints. These weak institutions’ depositors can now anticipate being made whole if the institution fails. Accordingly, they will cease to play any monitoring role within the financial system.
And make no mistake: bank executives will be motivated to take on a lot more risk. On one hand, if their risky loans do not become non-performing, their institutions will reap large profits, and they will be compensated handsomely. On the other hand, if their loans go south, they will just leave the bank and move on to the next thing (recall that SVB paid out bonuses on the very day that it was failing).
…..In Japan, where the inflation rate is much lower than in the US and Europe …… and the Bank of Japan is still intervening in the market to cap the ten-year bond rate at 50 basis points. But if the inflation rate in Japan continues to rise for the rest of the year, some regional Japanese banks may confront liquidity crises, which could trigger bank runs. Though this is far from the baseline scenario, it cannot be ruled out.
Over the last few months, a G7 economy (the United Kingdom), a midsize US bank (Silicon Valley Bank), a small African economy (Ghana), a lower-middle-income South Asian economy (Pakistan), and the fastest-growing global services sector (technology) have all faced short-term cash constraints. Monetary-policy tightening in the United States – where the Federal Reserve raised interest rates by 475 basis points in the space of a year – has produced knock-on effects around the world. But the stark disparities in how these effects are being treated speak volumes about current global financial arrangements. As in past systemic crises, this one is revealing major flaws in the international financial system. Vera Songwe, Chair of the Liquidity and Sustainability Facility, is a non-resident senior fellow at the Brookings Institution, wrote in Where Is the Global South’s Rescue Brigade?
In another article The Fed’s Role in the Bank Failures by Raghuram G. Rajan, former governor of the Reserve Bank of India, and Viral V. Acharya, a former deputy governor of the Reserve Bank of India, pointed out There are four reasons to worry that the latest banking crisis could be systemic. The article re-examines bank behavior and supervision, reminds the Fed that it cannot afford to ignore the role that its own monetary policies (especially QE) played in creating today’s difficult conditions.
The two authors called attention to a under-appreciated fact in a paper presented at the Fed’s annual Jackson Hole conference in August 2022. As the Fed resumed QE during the pandemic, uninsured bank deposits rose from about $5.5 trillion at the end of 2019 to over $8 trillion by the first quarter of 2022.
Yanis Varoufakis, a former finance minister of Greece, is leader of the MeRA25 party and Professor of Economics at the University of Athens, suggest in Let the Banks Burn, ” In fact, regulators and central banks knew everything. They enjoyed full access to banks’ business models. They could see vividly that these models would not survive the combination of significant increases in long-term interest rates and a sudden withdrawal of deposits. Even so, they did nothing. “