Depositor discipline and the banking panic of 2023

• Published date: 01 June 2023
• Author: Paul Kupiec
• Date: 01 June 2023
• DOI: http://doi.org/10.1111/jacf.12574

DOI: 10.1111/jacf.12574

EXECUTIVE SUMMARIES

Depositor discipline and the banking panic of 2023

Paul Kupiec

The author uses the recent failures of Silicon Valley Bank, Sig-

nature Bank, and First Republic Bank to reexamine whether

short-term creditors, including uninsured depositors, play a sig-

nificant role in moderating bankers’ appetite for taking risks.

Short-term creditors would be a source of market discipline if

they systematically identify risky bank behavior and charge higher

interest rates and limit credit to banks with elevated risk profiles.

If this were the case, bank managers would have to anticipate the

inevitability of elevated funding costs when evaluating the prof-

itability of a risky business venture. In fact, there is a significant

body of academic literature supporting the hypothesis that short-

term creditors and depositors can impose market discipline on

banks.

This academic literature mostly predates the Great Financial

Crisis; however, much has changed since then. The failures of

the banks mentioned above suggest that even uninsured deposi-

tors and creditors no longer provide the credit quality monitoring

that policymakers hope to find. All three banks were seriously

undercapitalized if not insolvent once the banks’ unrealized mark-

to-market losses on their securities and loans became generally

known. The puzzle is why uninsured depositors did not begin to

withdraw their balances sooner.

As even uninsured depositors were ineffective monitors of credit

quality before March 2023, only bank regulators could have ful-

filled that role. Unfortunately, the 10K reports of these banks

indicated that none were subject to regulatory directives requir-

ing them to increase capital or liquidity. SVB received a mildly

disappointing review from regulators while the other two received

satisfactory grades. First Republic Bank was deeply insolvent, yet

its regulatory capital ratios indicated that the bank was “well cap-

italized” as of 2023Q1, just before it failed. If not for uninsured

depositor runs, these banks would not have been closed by their

bank regulators. The failure of bank supervisors to exercise their

duty to impose prompt corrective measures on these banks pre-

emptively despite ample powers and obvious evidence of these

banks’ diminished safety and soundness is problematic.

AMERICAN ENTERPRISE INSTITUTE

ROUNDTABLE ON ADDRESSING THE

UNDERLYING CAUSES OF THE BANKING

CRISIS OF 2023

Paul Kupiec, Charles Calomiris, Andrew Levin, Bill Nelson, Alex

J. Pollock

Despite repeated assurances from Federal Reserve Chair Pow-

ell, Vice Chair of Supervision Barr, and Secretary of the Treasury

Yellen that the banking system is sound and well capitalized, the

banking system was stricken with an old-school depositor panic in

the first weeks of March 2023. Massive runs by uninsured depos-

itors caused the failure of two large institutions over the second

week in March while billions more in deposits fled several large

regional banks in the coming weeks, ultimately causing a third

large bank to fail.

The bank panic caused the administration, the Federal Reserve

Board, and the FDIC to declare a “systemic risk exception”

and guarantee all deposits in Signature Bank and Silicon Val-

ley Bank. This blanket guarantee will cost the deposit insurance

fund losses in excess of $22 billion, losses that will be transferred

to well-managed banks and ultimately to taxpayers. A normal

least-cost resolution of these banks would have cost the insurance

fund nothing because these banks had minimal insured deposit

balances.

To describe this banking panic as “unanticipated” would be a

gross understatement as none of the failed banks was listed as a

“problem bank” by their regulators and all were rated “well capi-

talized” by regulatory standards when they failed. While federal

regulators were quick to blame flawed bank risk management

for these failures, the truth is that these failures are as much a

consequence of a gross miscarriage of bank supervision. Bank

supervisors failed in their duty to preemptively impose prompt

corrective action remedial measures to correct the obvious safety

and soundness issues that caused these banks to fail.

This edited transcript of this May 2023 AEI event discusses the

underlying economic environment that created conditions that

precipitated this mini-banking crisis. It discusses specific bank risk

management failures and the shortcomings in supervision and

regulation that led to these bank failures. Panelists provide their

views on changes in Federal Reserve monetary and bank regula-

tory policies that could help to prevent a future reoccurrence of

such events.

FURTHER REFLECTIONS ON THE COLLAPSE

OF THE SILICON VALLEY BANK

Oonagh McDonald CBE

While acknowledging the inadequacy of bank regulation in the

months or even years before the collapse of the Silicon Valley

Bank, the author emphasizes that policymakers and shareholders

4© 2023 Cantillon & Mann.J. Appl. Corp. Finance. 2023;35:4–6.wileyonlinelibrary.com/journal/jacf