Relaxation of financial rules: catalyst for SVB’s bankruptcy?

History of financial rule relaxation

Since the 2008 financial crisis, financial regulators have taken steps to strengthen the stability of the financial system and protect consumers. This was the case in Europe with the “European Union Financial Reform Package,” and in the United States with the adoption of the Dodd-Frank Act starting in 2010, which imposed strict rules on banks to limit the risk of bankruptcy and improve transparency.

However, according to many observers, the Dodd-Frank Act, with its thousands of pages of regulations, has proven too complex to implement, causing unintended side effects such as slowing economic growth due to restrictions it imposes on credit access. In the end, it only partially met its initial goals, namely, financial regulatory reform and the prevention of financial institution failures.

As a result, the U.S. Congress passed a law in 2018 that relaxed some of the strictest rules of the Dodd-Frank Act. In this regard, the reduction of regulatory compliance costs for small and medium-sized banks, the relaxation of rules related to cross-border activities, and the ability for neo-banks to obtain federal banking charters, previously open only to traditional banks, acted as a catalyst for the rise of neo-banks such as SVB (Silicon Valley Bank).

The fall of SVB

Following the bankruptcy of SVB, some analysts believe that this relaxation of financial rules was the main cause of this bankruptcy. SVB was an American bank, founded in 1983, to meet the financial needs of Silicon Valley companies and until recently, enjoyed an excellent reputation in the markets. Many tech companies were thriving and had significant cash flows that they deposited with SVB. However, following the rise in interest rates, SVB experienced a “scissors effect” in two stages:

1. The funds held for clients were placed in U.S. Treasury bonds, a relatively secure asset similar to bonds; but due to the recent rise in interest rates, these assets lost a substantial portion of their value, as the displayed interest rates became lower than market rates;
2. Meanwhile, the technology sector began to struggle to obtain financing from usual venture capital funds and withdrew a significant portion of their deposits, leading SVB to sell its assets at a loss to meet its obligations.

This led to a crisis of confidence among depositors who sought to withdraw their funds en masse, resulting in SVB’s bankruptcy and the seizure of its remaining assets by federal authorities.

How was financial regulation relaxation beneficial?

The advantages of regulatory relaxation for neo-banks are numerous for both the system itself and customers, whether it be disrupting the traditional banking model, democratizing access to financial services, or offering innovative products. The rise of neo-banks allows a wider audience to benefit from cheaper financial products with an improved customer experience (e.g., mobile apps, 24/7 availability and assistance).

However, this relaxation, if not balanced—as seen in the case of SVB’s bankruptcy—also brings challenges. First, neo-banks still struggle to obtain a banking license. Although the rules have been simplified for new entrants, it remains difficult for them to meet regulatory requirements and obtain a banking license. As a result, some neo-banks have opted for partnerships with established banks rather than obtaining their own banking license. Additionally, neo-banks may still face challenges in raising funds. Although capital requirements have been relaxed, investors may be more reluctant to invest in non-established and high-risk companies. Finally, neo-banks must face increasing competition from large banks, which are also seeking to innovate and adapt to changes in the financial services industry.

That said, neo-banks have benefited from less stringent regulations regarding capital and liquidity requirements, allowing them to innovate faster and develop products and services that meet consumer needs. Neo-banks have unique advantages in terms of agility and the ability to focus on specific market niches, such as small businesses or millennials, and develop products and services that specifically meet their needs.

Providing specialist perspective on the SVB situation

Silicon Valley Bank was seeking to quickly raise capital to cope with massive client withdrawals. Without succeeding, they triggered a panic in the markets. The announcement caught investors off guard and reignited fears about the solidity of the entire banking sector, especially with the rapid rise in interest rates that drove up the cost of credit. American banks recorded a $52 billion loss in the stock market, and this trend then spread to Asian and European banks, including Société Générale, which lost 4.49%, BNP Paribas 3.82%, and Crédit Agricole 2.48%.

In Europe, Deutsche Bank also lost 7.35%, Barclays 4.09%, and UBS 4.53%. Fortunately, major Wall Street banks recovered from the previous day’s rout and posted gains on Friday, with a 2.54% increase for JPMorgan Chase, while Bank of America and Citigroup lost less than 1%. Medium-sized banks, however, faced more difficulties, with First Republic losing nearly 15% and Signature Bank, close to the cryptocurrency industry, falling by 23%.

The consequence is simple: a crisis of confidence in the system once again hit the financial sector, prompting SVB depositors to withdraw their funds en masse. In most situations, this typical crisis of confidence often leads to the collapse of the targeted financial institution, whether it is a large institution or a smaller entity, such as neo-banks.

Relaxing financial rules can have advantages and disadvantages depending on the circumstances. On the one hand, relaxing financial rules can stimulate economic growth by facilitating access to credit for businesses and individuals, which can encourage investment and consumption. It can also help financial institutions overcome difficult periods, such as economic recessions.

On the other hand, relaxing financial rules can also lead to risks. For example, it can result in increased household and business debt, which can increase the risk of defaults. It can also encourage risky financial practices, such as speculation or excessive leverage.

As in many areas, “the dose makes the poison,” and it’s all about finding a balance between regulation and relaxation, with the excess of one or the other bringing its own set of risks. There is still no perfect balance between the two sides of the scale, and that is perhaps the lesson to be learned from the SVB bankruptcy, which reminds us that the history of the financial system has been built on its crises and attempts to adjust.