All the banks passed their stress test this year

https://www.federalreserve.gov/newsevents/pressreleases/bcre...

Regulators have been putting immense pressure on big banks to hold adequate capital reserves since 2008 and they have been especially turning up the heat for the last 5 years. Moreover, it is clear that regulators will never allow a US bank to hold more than 3% of assets as crypto ever again.

Those government-mandated, ultra-safe capital reserves look like they're actually the big problem that's going to bring down banks right now. Banks have stuck a bunch of their reserves in really safe, predictable, high quality long-term bonds (particularly government issued ones). Because interest rates have gone up, those bonds are now worth substantially less than they were a year or so ago, meaning that the banks' ability to cope with people and businesses withdrawing their deposits has gone down substantially.

Interest on loans should by increase a banks reserves every year barring massive defaults. The ROI for the actual reserves aren’t particularly relevant by comparison.

Similarly from a reserve standpoint they don’t need to worry about inflation as they need to pay back deposits in nominal terms not what the money is worth when withdrawn.

Higher interest rates decrease the value of long-duration bonds even in nominal terms. Think of it this way: because the interest rate on a bond is fixed at issue, and because newer bonds now have higher interest rates, your existing bonds have to be sold for less in order for someone to buy them over a newer higher-interest bond. This means that the banks' reserves have actually shrunk in value. This is made worse by the fact that the combination of low interest rates and requirements to choose safe investments means that the only way for banks to meet their cost of operations is by picking longer-duration bonds which have higher drops in value, and that they haven't been earning enough interest to really grow their reserves either.

That’s only relevant if you need to sell it or use mark to market accounting.

The US banking system has been given a great deal of regulatory leeway due to recent economic turbulence, including setting reserve requirements to 0%. So market value is only relevant if they need to sell before maturity.

> So market value is only relevant if they need to sell before maturity.

Which is exactly what needs to happen when depositors ask for their money back.

Not typically.

Banks generally have liquid reserves to handle significant fluctuations in deposits. If that’s insufficient they have incoming cash flow and the option to borrow money to make up the difference rather than instantly selling assets.

Thus in practice extracting 5% over a week is fine but there’s a threshold that will kill any bank.

> Similarly from a reserve standpoint they don’t need to worry about inflation as they need to pay back deposits in nominal terms not what the money is worth when withdrawn.

The issue is that the sale value of their reserves has dropped below that nominal value. If you take in $1000 of deposits that you're paying 1% interest on and your reserve against that is a 10-year $1000 T-bill with a 2% coupon, you'd think you're fine, right? But if interest rates go up to 3%, you can't sell that T-bill for $1000 any more; if you can hold it to maturity you're fine, but if your customers start pulling their deposits you're in trouble.

Why would customers be pulling deposits unless you are offering lower than market interest rate? If T-bills are 3%, they can pay depositors 2% now and so whatever condition kept the customers there at -1% risk premium would still keep them there. No run on the bank. And given they are T-bills, duration is minimal, so $1000 might be worth $990 even before coupons. Whoop-de-doo!

There would only be a problem if the bank's credit deteriorated in its risky assets, enough to freak depositors out.

> Why would customers be pulling deposits unless you are offering lower than market interest rate?

Any number of reasons, particularly if all your customers are in the same industry. If you're "Silicon Valley Bank" and there's a downturn in Silicon Valley, well, here you are.

Yeah, this is how it's similar to silvergate. The main issue silvergate had was a lack of diversification of their liabilities, I.e. their depositors were all crypto. So when crypto hit a liquidity crises, it cascaded to silvergate. The same thing could theoretically happen to SVB, although that would look very bad on tech, since tech shouldn't really be an industry unto itself. Ideally, tech is just technology, and its application is across any industry.

This is incorrect, as we learned from Silvergate. Customers pulled their deposits for reasons unrelated to the bank (in Silvergate’s case, the customers of the crypto exchanges wanted all their money back, so the crypto exchanges had to withdraw their deposits from Silvergate).

As Levine put it, it’s not an asset problem, it’s a liability problem.

It is not unrelated to the bank. They took concentrated callable funding that somehow was not matched to the liquidity of their assets. They took a risk.

This doesn't work either. Remember, the reason that the market value of the T-bills in their reserves has dropped is that the interest rate on them is lower than the current interest rate that people can get by buying them now, so the bank likely cannot afford to pay their customers a market interest rate of 1% below that. The only way for the hold-to-maturity value of their reserves to actually be realised is if customers don't withdraw their deposits and they don't have to substantially increase the interest rates they pay in order to achieve that - otherwise they're likely to run out of money, either quickly or slowly.

You nailed it I think.

Right now there will be a lot of chatter if the root cause was industry concentration, mark to market, junior VCs scaring gulible founders, or as you pointed out: duration risk.

I think in five years the common narrative will be about duration risk.

To spell out what you hinted at: SVB will collapse at some point in the next few years. The only scenario they survive is if they survive this bank run, and then soonsih the fed lowers interest rates by a ton.

Otherwise even without this bank run SVB will still slowly be forced to sell off more and more HTM assets. Core reason being they cannot cashflow wise offer market rate interest on deposits. Clients _would_ move their money to better paying banks, not everyone but too many.

Thus this bank run only accelerates the inevitable. The interest broader note is how other bigger banks have or have not managed their exposure to duration. And special eyes towards the Japanese MegaBanks, double so if the bank of Japan does raise rates.

I was talking about offering it to new deposits. If your old deposits are not duration-matched then yes, you are screwed.

This is why there is a difference between a banks assets and their liquid assets.

If the T-Bill has a maturity beyond 90 days it doesn’t qualify as a liquid asset.

The parent commenter is right, and the problem is the mark-to-market rule. This means that the value of the asset must be the current trading value, which goes down as the rates go up. The result is that bank reserves will go down substantially in nominal terms, sometimes faster than they can recoup the value of these investments.

That’s a regulatory rule which can be suspended not the underlying economic reality. “On April 9, 2009, FASB issued an official update to FAS 157[35] that eases the mark-to-market rules when the market is unsteady or inactive.” https://en.wikipedia.org/wiki/Mark-to-market_accounting

We’re currently in some interesting times: “As announced on March 15, 2020, the Board reduced reserve requirement ratios to zero percent effective March 26, 2020. This action eliminated reserve requirements for all depository institutions.“. https://www.federalreserve.gov/monetarypolicy/reservereq.htm

The key phrase here is "when the market is unsteady or inactive". Apparently this can be used to save banks, but not until there is trouble in the market.

respectfully, I'm not so sure. The decline in bonds applies to all fixed-rate securities. The only alternatives would have been just straight up cash (bad with inflation) or riskier, less-liquid assets (non-tradable loans with floating rates, for example). They are limited on the latter by risk weighting, and I'm not sure having looser risk controls on the asset side would really help confidence in the banking sector.

please feel free to disagree!

Inflation isn’t a concern here. Depositors hand a bank 1 billion and X% inflation hits, well the bank still only owes them 1 billion.

Yeah that's true, it matter more for net-interest-margin / interest income generation in a rising-rate environment. Good point

a depositor isn't going to deposit 1 billion and only expect 1 billion back out months later. that's some poor people shit. Large sums of money like that, banks pay you for the pleasure of holding it. So a bank offering 4.5% APY like SVB offers would owe an extra 3.2 million to the billionaire if they look at their account a month later.

The problem is, the underlying assets that SVB owns will only pay them back at 1% APY, and only in 20 years or whatever, and the billionaire has been promised 4.5%APY and is expecting to have access to one months worth of interest next month. that 3.5 difference is thus a huge problem for SVB.

Could they instead hold short-term treasuries (as short as 4 weeks, I believe) and refuse to honor large withdraws until they mature?

Short term treasuries are definitely pretty common on the asset side, but if you refuse to honor withdrawals on demand deposits you won't have a bank anymore and the FDIC will step in to wind things down

Pardon my ignorance (not a crypto guy) — what is it that you're referencing when you mention a bank holding 3% of assets as crypto? My uninformed assumption is that this is either about Silvergate, or something related to SBF's debacle.

Just curious. As mentioned, I'm pretty ignorant about this and would like to educate myself.

As part of a general crackdown happening right now regulators put any crypto plans US banks may have had on ice.