The Economics and Political Science Room
It was the mismanagement of leverage in the context of rising interest rates that caused the bank failures. We all knew interest rates would rise. Yet these bank managers didn't, or ignored it.
The Role of Leverage in the Failures of Silvergate, Silicon Valley, and Signature Ban
Over the past two weeks, three medium-size banks—Silvergate Capital, Silicon Valley, and Signature—went out of business. They all had similar problems. They had financed their assets largely with debt, rather than equity. That is, they used substantial “leverage” to run their businesses.* In addition, there were indications that the value of their assets may be insufficient to meet regulatory equity minimums or, possibly, to cover the large, fixed claims of their creditors.
Why the banks failed
The real or potential financial weakness of these banks was revealed when large uninsured depositors—creditors with the ability to call debt instantly—began withdrawing funds. In the case of Silicon Valley and Silvergate, the forced sale of assets to meet depositor demands for cash showed that bank assets had lost value because of adverse market events. It became clear that Silicon Valley was insolvent, with the value of its debt exceeding the value of its assets, and that Silvergate’s equity levels were heading in the wrong direction. So Silicon Valley was shut down by regulators, and Silvergate voluntarily liquidated itself. In the case of Signature, New York state banking regulators apparently concluded that the bank could not survive an uninsured depositor run and shut it down.
The characteristics of the uninsured depositors differed across banks. In the case of Silicon Valley, many uninsured deposits were from tech firms. At Silvergate, a significant share of uninsured deposits were from crypto exchanges and hedge funds, which used the banks to transact with one another. Nearly 90 percent of Signature deposits were uninsured, and about 18 percent of its total deposits were digital-asset related, but it is not clear what fraction of the digital-related assets were uninsured.
The motivations for initial withdrawals were diverse. In the case of Silicon Valley, early withdrawals appear to have been tied to conditions in the tech industry. For Silvergate, the collapse of FTX and much of the crypto world appears to have started the ball rolling. The situation at Signature is less clear and may have been the consequence of contagion.
Whatever the starting point, the cash calls led to disaster because the banks had relied heavily on debt to finance their assets, rather than equity from their shareholders.
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