A security guard looks out a door as customers line up at Silicon Valley Bank headquarters in Santa Clara, California on March 13, 2023.NOAH BERGER/AFP/Getty Images
Brian Madden is chief investment officer of First Avenue Investment Counsel, a Toronto-based investment counsel and family office.
A wise friend of mine often quips that, “things can go from impossible to inevitable overnight, without ever pausing at improbable.” Last week’s stunning overnight collapse of Silicon Valley Bank (SVB), America’s 16th largest bank, into Federal Deposit Insurance Corporation receivership proved the point. It should also give Canadians pause for reflection, amidst all the echoes of 2008 and the ghosts of Bear Stearns, Washington Mutual, AIG and Lehman Brothers.
There were many factors behind SVB’s crash. It succumbed to the deadly cocktail of interest rate, funding and credit risk, plus poor internal risk management and governance. But ultimately SVB’s collapse is a statement on the failures of a too-open banking system.
The extraordinary backstop provided to SVB depositors by U.S. regulators emphatically proves that the bank was, at once, too big to fail (at least politically speaking), and too small to regulate effectively.
Stringent regulations applicable to the larger, systemically important banks under global Basel III banking supervision standards would have subjected SVB to liquidity coverage and net stable funding ratio tests, for instance. These tests are specifically calibrated to ensure banks can weather liquidity crises, or in lay terms, “runs on the bank,” such as the one that occurred last week.
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The concentrated inner sanctum of Canadian banking has plenty of critics. These critics slam Canada’s Big Six banks for what they see as their clubby oligopoly and the tidy little $60-billion in annual profits they generate, ringfenced from serious competition by regulatory licence.
Some critics have been advocating for open banking, decentralized finance, cryptocurrency and other reforms to digitally disrupt regulated banking’s status quo. They argue this would create a broader, more competitive and level playing field like the U.S. market, where literally thousands of banks compete aggressively.
But let’s be careful what we wish for – there absolutely is too much of a good thing when it comes to banking and deregulation, as the SVB fallout has shown.
Proponents of a less concentrated banking sector contend that such a system would be resilient to economic shocks, with no single bank requiring a bailout in the event of trouble because it is “too big to fail.” The proponents say such a system is perhaps even “antifragile” – a concept first attributed to financial author Nassim Nicholas Taleb, signifying a system that not only survives but actually thrives under stressors, shocks and volatility.
These proponents have a point, to be sure. In principle, deregulation and competition are benevolent and powerful forces in a dynamic economy.
For every legitimate and socially useful case of “innovation” in finance, however, there are easily a dozen snake-oil potions on the market. The rotting carcasses of Silvergate, FTX and other pioneers of the Wild West decentralized finance (“defi”) ecosystem are still fresh, to say nothing of this latest failure of conventional banking.
With great profit comes great responsibility. Canadian banks operate in the private sector, earning profits for their shareholders, but they quite rightly operate under a social and regulatory licence and bear a responsibility to provide a public good – safe, stable banking for households and businesses.
The regulation of banks in Canada is indeed stringent and creates barriers to competitive entry, and has had the effect of concentrating significant market share in the hands of a small number of incumbent banks. So, no, regulation is not a panacea. But effective regulation does safeguard the public interest and support depositor confidence in banks, without which they cannot continue to operate – not even for a day – as SVB stakeholders learned the hard way.
Certainly, let’s continue to celebrate entrepreneurs, disruptors and innovators, as well as the startup ethos of “move fast and break things.” But let’s not forget that safe, stable and well-regulated banking is a vital public good, just like safe streets and clean air.