Today’s Policy Responses to Bank Failures Nod to Lessons of 2008

Following its collapse, Silicon Valley Bank was seized by regulators on March 10 after what has been described as the first social media-driven bank run. Over a weekend, the startup world scrambled to address a loss of access to operating cash.

The Federal Deposit Insurance Corporation immediately announced it would backstop insured depositors, who would have access to their insured funds—up to $250,000 per account type—by no later than March 13. This announcement did little to ease market fears, and $250,000 was insufficient for the basic payroll needs of many of the bank’s clients.

Market sentiment darkened further as federal policymakers announced that there would be no bailout. Certain other regional banks came under significant strain and one—Signature Bank—failed. Some commentators warned of an extinction-level event for the startup industry.

Then, as abruptly than it started, the crisis passed. On March 12, the federal government invoked a systemic risk exception for both Silicon Valley Bank and Signature Bank. Top policymakers jointly announced that depositors would be made whole by the following day.

Bridge banks were established for both institutions, and normal banking services resumed. Ultimately, the deposit liabilities and a substantial portion of the assets of both banks were acquired—by First Citizens Bank in the case of Silicon Valley Bank and by Flagstar in the case of Signature Bank.

Lessons from 2008, and Response

The speed of the policy response is a legacy of harsh lessons learned from the 2008 banking crisis, and points to how substantial banks in crisis may be resolved in the future. One possible lesson of 2008 was that policymaker adherence to the normal rules of the road is less important than maintaining market confidence during an emerging banking crisis.

Without question, there are costs to this approach. But the tail risks associated with a banking crisis are so extreme that policymakers appear to have decided that they substantially outweigh those costs. This mindset informed the resolution of Silicon Valley Bank.

When a buyer did not immediately emerge, and with the contagion spreading, policymakers acted decisively by placing the full faith and credit of the US behind deposits at both banks.

The Federal Reserve also dug into its 2008 toolkit to make an extraordinary new lending facility available to eligible depository institutions. These institutions could pledge treasuries, mortgage-backed securities, and certain other qualifying assets at par, as collateral for loans of up to one year. The program’s goal is to prevent the problem that sparked the run on Silicon Valley Bank—forced sales of securities that trade below par as a result of a rising interest rate environment.

What Comes Next

The events of the past month show that when sizable banks fail and a crisis appears to be emerging, policymakers are increasingly willing to quickly deploy the regulatory equivalent of overwhelming force to prevent any risk of a replay of even the shadow of the 2008 crisis. This has important implications.

Confidence in the stability of the banking system should be strengthened. When something goes wrong at an institution of sufficient size, the market will now be more inclined to believe the government will do whatever is necessary to protect depositors. That should take some momentum out of potential future bank runs.

Questions will be asked about how big, or specialized, an institution must be to enjoy extraordinary protection from the federal government. This is likely to benefit large banks that nevertheless fall below the systemically important institution threshold, but may come at the expense of institutions that are clearly small enough that they could safely be allowed to fail.

Moral hazard abounds. Depositors have less incentive to examine the fundamental soundness of their banks. The $250,000 FDIC insurance limit is likely to be regarded as relatively meaningless for institutions of sufficient size. Moreover, the preferred tool in the FDIC’s arsenal following a bank failure is to identify a willing buyer for the failed bank as a whole.

Finding such a buyer is likely to become more difficult in an environment where potential suitors are encouraged to hold out and wait for extraordinary government support for a failed bank. That makes it more likely that such extraordinary government support will be necessary.

Expect a hunt for villains—2008 taught that lambasting banker compensation is politically popular. We have seen the start of this already in President Joe Biden’s recent statement urging Congress to pass legislation providing regulators with broader powers to punish and claw back compensation from executives deemed responsible for the collapse of financial institutions.

Finally, expect regulators to push down to broader categories of banks, some of the more onerous post-2008 prudential regulatory standards. In 2008, that meant a sweeping reimagining of the banking regulatory landscape and the types of risks that banks would be permitted to assume. Here, expect further calls to make banking boring, and targeted efforts at addressing duration mismatch risks.

Banking risks are not going away, but the speed and breadth of the policy response to the recent potential crisis shows that policymakers took lessons from 2008 regarding the need for immediate crisis containment. Expect the path ahead to be informed by the belief that the potential risks of any sizeable bank failure justify the costs of decisive government action.

This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.

Author Information

Tim Byrne is a partner at Norton Rose Fulbright specializing in bank regulatory matters.

Eric Daucher is a partner at Norton Rose Fulbright, where he heads the firm’s restructuring practice.

Tom Delaney is a partner at Norton Rose Fulbright specializing in bank regulatory and enforcement matters.

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