The Fed Is Hunting Bank Runners

But is it a wrong turn from hunting the bank runs?

Fed Vice Chair for Supervision Michael Barr finally officially discussed the Fed’s thinking on liquidity reforms—first reported by the New York Times in March—last week.

The reforms consist of few initiatives for banks “over a certain size”:

• Establishing a supervisory expectation of discount window readiness, inclusive of prepositioning collateral at the discount window such that the sum of lendable discount window collateral value + the bank’s reserves = some sufficient proportion of uninsured deposits

  • The WSJ has reported the Fed is hovering around a requirement of 40% of uninsured deposits.

• Limiting banks’ inclusion of held-to-maturity assets in their calculations of regulatory liquidity ratios—due to the drawbacks/challenges of monetizing HTM assets.

• Ratcheting up liquidity regulations’ deposit outflow assumptions because: “Observed deposit withdrawals from high-net-worth individuals and companies associated with venture capital or crypto-asset-related businesses suggest the need to re-calibrate deposit outflow assumptions in our rules for these types of depositors.”

• And, broadly, “revisiting the details of the application of our current liquidity framework for large banks.” Presumably, this is about bringing more banks into the fold of the full LCR, etc.

Assuming higher outflows for crypto and high-net-worth individuals

While the discount window stuff has gotten much of the focus, the third bullet has perhaps gone a bit under-scrutinized.¹ Frankly, it’s a bit surprising the crypto diehards haven’t yet latched onto it as another “operation chokepoint” meant to squeeze crypto out of the system. (This is not a suggestion!)

High-net-worth individuals

Regarding high-net-worth individuals, it may make sense to assign them their own assumptions in liquidity regulations. As of now, the US liquidity coverage ratio (LCR), which mandates enough liquidity for a hypothetical 30-day stress period, distinguishes between “stable” and “less stable” retail deposits—which is roughly insured and uninsured deposits, respectively.

Stable deposits are assumed to have a runoff rate of 3% in a 30-day stress window, while less stable deposits get 10%. (The Basel LCR guidance suggests 10% and up for less stable deposits, and they give specific mention to high-net-worth individuals.) This compares with assumed outflows of 20%-100% for other various categories of institutional or brokered deposits.

Indeed, it may make sense to consider deposits from high-net-worth individuals as more akin to financial/institutional deposits. Much like institutional depositors, these “retail” depositors:

• Lack deposit insurance coverage after $250,000;

• Are more likely to have accounts at multiple banks already established, which hastens transfers;

  • This proved a delay for many firms trying to transfer out of the likes of SVB; they had to first establish an account at another bank.

  • First Republic, meanwhile, got deposit inflows on March 9, 2023, the first day of SVB’s run—suggestive of the overlapping clientele with SVB. (Massive outflows for First Republic, however, followed on March 10.)

• Are likely more attuned to financial news; and

• Related to the previous two bullet points, may be receiving institution-level financial advice from their advisors/brokers.²

  • For instance, regarding First Republic (the main reason we’re talking about high-net-worth depositors): The FDIC inspector general reported that FDIC staff said “several large money center banks began advising their clients to pull their funds from First Republic” on March 10, 2023 (the day regulators seized SVB).³

Thus, it may make sense to think of these individuals less as “less stable” retail depositors and more like institutional ones.

Venture capital and crypto deposits

Notwithstanding that stablecoin deposits have special characteristics that add to financial instability (see, e.g., here), the proposal to specifically target venture capital and crypto firms with higher deposit outflow assumptions seems like overengineering to March 2023—when VC and crypto banks failed.

No doubt, SVB and Signature Bank failed in no small part because of their VC and crypto deposit bases and business models. However, it’s not at all clear that those depositors ran any faster than other institutional depositors would have (and did… see below).

SVB and Signature saw deposit runoff from VC and crypto well prior to their run. SVB’s deposits fell about 12.5% from Q1 to Q4-2022 amid VC cash burn.⁴ Signature lost a slightly higher percentage in Q4-2022 alone, the quarter when FTX blew up.⁵ These runoffs were related to the macroeconomic sensitivity of these deposits.⁶ With the Fed hiking rates swiftly and severely, the cash drain in the economy’s most bubbly sectors was on. The interest rate sensitivity was in their liabilities as much as it was in SVB’s assets (Signature did not have material mark-to-market duration losses).

But, that’s a problem for supervision—or, perhaps in the future, an input into how much collateral these banks should have been required to preposition at the discount window. It’s not what’s captured in the LCR’s focus on a 30-day stress period.

Indeed, as the New York Department of Financial Services noted in its postmortem of Signature: “the percentage of digital asset customer withdrawals on March 10 was relatively proportional to the percentage of digital asset customers in the deposit base overall.” That is, the run by crypto clients was as extreme as for the other 82% of Signature’s (largely uninsured) deposit base.

The NY DFS added that, “The bigger issue for Signature was that the Bank had a high concentration of uninsured deposits and was perceived as a crypto bank” (emphasis added).

It’s not as if mortgage firms ran any faster in 2008 than everyone else. Institutional runs are institutional runs are institutional runs.

Comments also welcome via email (steven.kelly@yale.edu) and Twitter (@StevenKelly49). View Without Warning in browser here.

1. Necessary caveat to this whole discussion: The liquidity solutions to March 2023 can’t be to just ratchet up self-insurance liquidity requirements until every bank is effectively a coffee can. Banks are already substantially less bank-like given post-GFC liquidity regs:

Source: Fed Board

I’m certainly not suggesting undoing those requirements, but we still got the fastest bank run ever. This is where things like giving regulatory “credit” towards (potentially increased!) liquidity requirements for prepositioned discount window collateral can strike the right balance of carrot and stick without disintermediating banks.

2. They also may be associated with “institutions” themselves. i.e., high-net-worth individuals whose wealth derives from high-earning positions in (particularly financial) firms, may follow their firm’s money out the bank’s door.

3. In addition to the generally high-quality financial intelligence/advisory functions of the big banks… As an excellent recent NY Fed study of confidential interbank payments data noted: The largest banks, by being the main beneficiary of deposit outflows on other banks, could see in the transfers activity which banks were facing deposit runs.

4. These figures are from quarterly call report data.

5. Some of these deposits were pushed away as Signature announced an intent to reduce its digital-assets-related deposits. But, of course, it pushed them away due to the market’s increasingly unfavorable view of such deposits.

6. Notably, First Republic faced no such runoff. It actually grew deposits throughout 2022, suggesting it was a much more viable institution on a going concern basis than SVB and Signature. Alas, such is the cost of losing the “open bank” systemic risk exception authority authorities had in 2008.