24 July 2023
The collapse of Silicon Valley Bank has unveiled serious vulnerabilities in the financial sector, shedding light on inadequate regulatory measures and financial missteps. The prevalent disregard of rising interest rates and reckless betting by financiers has significantly contributed to the collapse. Loose monetary policies and flawed accounting rules are among the key factors, with additional concerns being the overlooked roles of the Federal Home Loan Bank system (FHLB) and the use of collateral.
The FHLB, an obscure entity in American finance, has facilitated loans for struggling institutions, masking their actual financial conditions. An alarming spike in FHLB’s loan book from $344bn to over $1tn between September 2021 and March 2023, largely undetected due to lack of timely reporting, has been revealed. The banks that imploded, including SVB, Signature and First Republic, were found to be heavy FHLB borrowers.
Further, the misuse of collateral to secure loans has been identified as another potential threat to banking stability. While it was intended to enhance safety, the excessive use of collateral has instead diminished incentives to screen borrowers and monitor risks, escalating aggregate leverage and liquidity risk.
The SVB failure indicates that the current financial system is fostering more, not less, aggregate risk, as the provision of safety nets tends to undermine market discipline. Urgent discussions and reforms are needed to prevent similar distortions in the future, potentially overhauling or abolishing the FHLB and reconsidering the use of collateral in finance.