SILICON VALLEY BANK: A CASE STUDY IN RISK, REWARD, AND REGULATION
SILICON VALLEY BANK: A CASE STUDY IN RISK, REWARD, AND REGULATION
By Thomas Carter | March 13, 2023
When we turn to face our blind spots, sometimes it’s possible to reveal limitless ideas.
Entrepreneurs, the business world’s dream makers, see many opportunities and needs from a consumers’ lens and then imagine and manifest solutions. Filling consumers’ needs can bridge communities with entrepreneurs and companies, but biases can cause missed opportunities.
This is especially painful when regulators are in the mix.
Regulators play a critical role in the financial services industry. They are responsible for ensuring that financial institutions and markets operate safely and soundly and that consumers are protected from fraud and abuse.
Some of the critical roles and responsibilities of regulators in the financial services industry include the following:
1. Supervision: Regulators supervise financial institutions and markets to ensure compliance with laws and regulations and to identify and address any potential risks to financial stability.
2. Rulemaking: Regulators create rules and regulations to govern financial institutions' behavior and market participants' behavior to promote industry safety, soundness, and fairness.
3. Enforcement: Regulators enforce laws and regulations and may impose penalties or sanctions on institutions or individuals that violate them.
4. Consumer Protection: Regulators also work to protect consumers by requiring institutions to provide clear and accurate information about their products and services and by investigating and taking action against fraud and abuse.
5. Crisis Management: In a financial crisis, regulators may take steps to stabilize the markets and prevent further harm to the economy.
Regulators also play a crucial role in the banking industry. They are responsible for ensuring that banks operate safely, soundly, and in compliance with applicable laws and regulations.
The primary role of regulators is to protect depositors' interests and maintain the financial system's stability. But it would be an understatement to say that they’ve fallen asleep at the wheel in recent years. With the housing crisis only taking place 15 years ago and the aftermath of the FTX scandal going on today, there’s much to be said about the reactionary approach to markets on behalf of the regulators.
Most unfortunately, this weekend, regulators bailed out venture capital in the aftermath of the run on Silicon Valley Bank. Not only that, but they’ve made it blatantly apparent that lousy and toxic management has the potential to be rescued and even rewarded. But before we point fingers, let’s step back to see the complete regulatory picture. Republicans primarily, although some democrats back in 2019 voted for the EGRCCPA.
EGRRCPA stands for the Economic Growth, Regulatory Relief, and Consumer Protection Act, a U.S. federal law enacted in May 2018. The law is also known as S.2155, named after the bill that became law after being passed by Congress and signed into law by the President.
The EGRRCPA aims to provide regulatory relief to banks and financial institutions, particularly smaller banks and credit unions while strengthening consumer protections. The law made several changes to the Dodd-Frank Wall Street Reform and Consumer Protection Act, enacted in response to the global financial crisis of 2008.
Some of the key provisions of the EGRRCPA include the following:
1. Raising the asset threshold for banks to be designated as "systemically important", thereby subjecting them to more stringent regulatory requirements.
2. Providing relief for small banks and credit unions from specific regulatory requirements, such as mortgage lending rules and annual stress tests.
3. Expanding consumer access to credit by removing certain restrictions on small-dollar loans and making it easier for consumers to get credit reports.
4. Increasing consumer protections by requiring credit reporting agencies to provide free credit freezes and removing certain credit report information.
Overall, the EGRRCPA seeks to balance the need for regulatory oversight and consumer protection with the desire to reduce regulatory burdens on smaller banks and credit unions.
Once that vote came in, it revoked substantial liquidity and stress testing requirements for those banks around the size of SVB (which, by the way, Republicans should be working with democrats to repeal – it has severely and systematically damaged our economy and unsuspecting ordinary Americans).
We need to return to Title 1 Dodd-Frank, signed in 2010. Well, hold on, let’s be clear. Title 1 of the Dodd-Frank Act has yet to be overruled, decommissioned, or ended. The law remains in effect, and the Financial Stability Oversight Council (FSOC) and the Office of Financial Research (OFR) established under Title 1 continue to operate.
However, since its enactment in 2010, there have been some efforts to modify or repeal specific provisions of the Dodd-Frank Act, including Title 1. One specific example was in 2017, when the U.S. Congress passed EGRRCPA, which made several changes to the Dodd-Frank Act, including raising the asset threshold for banks to be designated as "systemically important" and exempting some smaller banks from specific regulatory requirements covered earlier in this blog post.
When this change occurred, institutions $50B and over weren’t considered systemically important. But by using this systemic risk exception for smaller banks, there was a leeway for bad decisions, as we’ve seen play out with the crash of SVB—and there’s quite a bit of blame on behalf of regulators.
Even if the bank is well-capitalized, the problem is that some banks (like SVB) can make shortsighted decisions and quickly become illiquid under this regulatory environment. And it can be lights out very quickly, even if the bank is capitalized. If you remember, Lehman was well capitalized, but it was illiquid and, as a result, became insolvent. These regulations have allowed small banks like SVB to grow too fast. There is no way SVB should’ve been allowed to grow that fast – In 2015, that bank was $40B in assets. It had increased to over 400% when it was closed to somewhere in the $210B.
When looking at the state of venture capital, one has to ask how this will affect the innovation cycle in silicon valley and beyond and what regulators can do to work together in favor of innovation. While too early to call, many analysts speculate whether this may be when equity crowdfunding steps out of the shadows and truly take a more prominent role in our innovation cycle.
Equity crowdfunding is a relatively new concept, and regulations have been evolving (slowly). In the United States, the JOBS Act of 2012 created a framework for equity crowdfunding, allowing companies to raise capital from many small investors through online platforms. The Securities and Exchange Commission (SEC) subsequently issued rules to implement the JOBS Act provisions, including requirements for companies and crowdfunding portals to register with the SEC and disclose certain information to investors.
While these regulations have enabled companies to use equity crowdfunding to raise capital, some critics argue that the rules may be too restrictive or burdensome, particularly for smaller companies. Here are several reasons why regulators may need to take a second look at equity crowdfunding, especially in the aftermath of the collapse of SBV:
1. Democratization of Investment: One of the main reasons for allowing more investors to participate in equity crowdfunding is to democratize investment opportunities. Relaxing requirements would enable more individuals to participate in investment opportunities that were previously only available to a limited group of wealthy investors.
2. Increased Investment Opportunities: Relaxing requirements for investors could also lead to an increase in investment opportunities. This could benefit entrepreneurs and small businesses by giving them more capital access.
3. Lowering Barriers to Entry: By reducing the requirements for investors, regulators could lower the barriers to entry for entrepreneurs and small businesses seeking to raise funds through equity crowdfunding. This could stimulate innovation and economic growth.
4. Ensuring Market Efficiency: Relaxing requirements for investors could help ensure market efficiency by providing more liquidity to equity crowdfunding markets. This could lead to more efficient pricing and increased investor participation.
Overall, regulators should act on behalf of innovation because it can benefit society, the economy, and individuals. That being said, it is essential to balance promoting innovation and ensuring that necessary regulations are in place to protect public safety and well-being.