{"id":1026211,"date":"2023-03-15T10:50:24","date_gmt":"2023-03-15T10:50:24","guid":{"rendered":"https:\/\/jacobin.com\/2023\/03\/federal-regulations-silicon-valley-bank-volcker-rule-investment-venture-capital\/"},"modified":"2023-03-15T10:55:15","modified_gmt":"2023-03-15T10:55:15","slug":"federal-regulators-gave-the-green-light-to-silicon-valley-banks-risky-investments","status":"publish","type":"post","link":"https:\/\/radiofree.asia\/2023\/03\/15\/federal-regulators-gave-the-green-light-to-silicon-valley-banks-risky-investments\/","title":{"rendered":"Federal Regulators Gave the Green Light to Silicon Valley Bank\u2019s Risky Investments"},"content":{"rendered":"\n \n\n\n\n

In the years leading up to Silicon Valley Bank\u2019s recent collapse, federal regulators granted the bank a special exemption from a key rule put in place to prevent banks from engaging in risky investments.<\/h3>\n\n\n
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\n A Silicon Valley Bank office is seen in Tempe, Arizona, on March 14, 2023. (Rebecca Noble \/ AFP via Getty Images)\n <\/figcaption> \n<\/figure>\n\n\n\n\n \n

In the years before Silicon Valley Bank (SVB)\u2019s sudden failure, federal regulators gave the firm a special exemption from rules designed to prevent deposit-taking banks from engaging in risky investments and financial speculation, according to records reviewed by the\u00a0Lever<\/em>.<\/p>\n

The move \u2014 which was a precursor to regulators later extending a similar exemption to the entire banking industry \u2014 coincided with Silicon Valley Bank, or SVB, continuing to invest in the high-risk venture capital industry in the lead-up to its collapse, which is the second-largest bank failure in US history.<\/p>\n

As the federal government now protects SVB\u2019s depositors from losses, the bank\u2019s demise has touched off\u00a0alarms<\/a>\u00a0about broader risk in the financial industry, just a few years after both lawmakers and federal bank overseers began\u00a0rolling back<\/a>\u00a0some of the reforms that followed the 2008 financial crisis.<\/p>\n

In this particular example of that deregulation, the Federal Reserve created significant carve-outs to the so-called Volcker Rule, named after former Fed chairman Paul Volcker. That regulation was supposed to prevent federally insured banks from owning or investing in private equity or hedge funds \u2014 opaque pools of assets that are considered illiquid, meaning they cannot be easily sold and turned into cash.<\/p>\n

In 2017, the Fed granted SVB a\u00a0five-year reprieve<\/a>\u00a0from the Volcker Rule. The decision allowed SVB, a major lender to the tech industry, to remain a traditional deposit-taking bank while also maintaining its risky investments in venture capital \u2014 a form of private equity that funds startups in the tech industry, which has recently been battered by mass layoffs and financial losses.<\/p>\n

A few years later, the Trump administration effectively granted this same exemption to the whole banking industry, allowing banks to\u00a0sponsor and invest<\/a> heavily in venture capital funds. As a result, SVB was able to continue investing in assets that the Fed deemed too risky for a federally insured bank in 2017.<\/p>\n

Although SVB was an outlier in terms of its high exposure to venture capital funds, other banks that became distressed\u00a0as turmoil spread<\/a> this week are also known for investing in and working with venture capital (VC) funds, including First Republic, PacWest<\/a>,\u00a0Western Alliance<\/a>,\u00a0Customers Bancorp<\/a>,\u00a0Zions Bancorp<\/a>, and\u00a0Comerica<\/a>.<\/p>\n

Experts say the pool of venture capital investments that regulators permitted to remain on SVB\u2019s balance sheet is worth examining when determining the causes of its collapse last week. Many of those assets were illiquid. Shortly before SVB failed, the bank was forced to sell off almost every one of its assets deemed \u201cavailable for sale,\u201d according to the\u00a0Financial Times<\/em><\/a>. That effort led to heavy losses and ultimately helped accelerate the run on the bank.<\/p>\n

\u201cWe\u2019ll never know if the bank would have collapsed had it followed the standard rules, like Volcker, and best practices,\u201d said a former congressional aide who helped draft the legislation establishing the basis for the rule, who was unauthorized to speak publicly on the matter in his current role.<\/p>\n

He noted, though, that SVB had substantial venture capital investments, and said that analyses of the bank\u2019s collapse should consider whether it was appropriate for regulators to permit such activities.<\/p>\n\n \n\n \n \n \n

Enabling Banks to \u201cEngage in High-Risk Activities\u201d<\/h2>\n \n

SVB\u2019s business was closely tied to the venture capital industry. The bank, founded in 1983, invested in venture capital and\u00a0loaned<\/a> tens of billions\u00a0to VC firms to help them manage their cash flow. Venture capital-backed tech firms were also\u00a0big depositors<\/a>\u00a0at SVB.<\/p>\n

The bank\u2019s growth prospects faced headwinds when Democrats passed their 2010 Dodd-Frank Wall Street reform law, in response to the 2008 financial crisis. That\u2019s because the law included a long-delayed provision, called the Volcker Rule, which was supposed to prevent banks from putting their money into riskier private equity and hedge fund investments.<\/p>\n

In 2012, SVB lobbied the Obama administration to exempt venture capital investments from the Volcker Rule. \u201cVenture investments are not the type of high-risk, \u2018casino-like\u2019 activities Congress designed the Volcker Rule to eliminate,\u201d the bank wrote<\/a>\u00a0in a letter to federal regulators.<\/p>\n

However, the final Volcker Rule<\/a>\u00a0issued by the Obama administration, which\u00a0went into effect<\/a>\u00a0in 2015, did not exclude venture capital. Officials explained that \u201cCongress explicitly recognized and treated venture capital funds as a subset of private equity funds in various parts of the Dodd-Frank Act.\u201d<\/p>\n

Still, the Fed granted SVB their Volcker Rule exemption in 2017, with Federal Reserve officials justifying the decision\u00a0by saying<\/a>\u00a0that the bank needed time to \u201cconform its ownership interest\u201d in \u201cilliquid funds.\u201d Agency officials enumerated which funds concerned them in the exemption letter, but the list was redacted. The Fed did not respond to a request for comment, but did announce\u00a0Monday<\/a>\u00a0that it would be reviewing its supervision of Silicon Valley Bank.<\/p>\n

Public records indicate that the list of illiquid investments referred to VC-linked funds. In its\u00a0latest annual report<\/a>, SVB discussed the expiration of its Volcker Rule exemption in July 2022, and said that it never needed to fully comply with the Fed\u2019s request to reduce its exposure to illiquid assets because regulators eventually extended a Volcker Rule exemption for venture capital investments to the entire banking industry.<\/p>\n

The industry-wide exemption, which went into\u00a0effect<\/a>\u00a0in October 2020, was a major victory for SVB, after the bank spent years lobbying for the outcome.<\/p>\n

When that venture capital carve-out was proposed in\u00a0January 2020<\/a>, Federal Reserve chair Jerome Powell said that banks offering \u201climited service\u201d to venture capital did \u201cnot raise the types of concerns the Volcker rule was intended to address.\u201d<\/p>\n

SVB was a\u00a0member<\/a>\u00a0of two lobbying groups, the American Bankers Association and Bank Policy Institute, that submitted\u00a0regulatory<\/a>\u00a0comments<\/a>\u00a0backing the exemption.<\/p>\n

One member of the Federal Board of Governors publicly questioned the proposed exemption.<\/p>\n

\u201cI am concerned that several of the proposed changes will weaken core protections in the Volcker Rule and enable banking firms again to engage in high-risk activities,\u201d\u00a0said<\/a> Fed governor Lael Brainard, a Democrat who now serves as a top economic aide to President Joe Biden, in a dissenting vote on the carve-out. \u201cThe proposal opens the door for firms to invest without limit in venture capital funds and credit funds.\u201d<\/p>\n\n \n \n \n

\u201cA Piece of the Puzzle\u201d<\/h2>\n \n

SVB\u2019s balance sheet ballooned in the years after the Fed first granted the bank its Volcker Rule exemption in 2017, as deregulatory policymaking and low interest rates fueled the proliferation of tech start-ups.<\/p>\n

One trade publication reported that 55 percent of the bank\u2019s loan portfolio, which grew to $61 billion by late 2021, consisted of\u00a0loans to VC and private equity firms<\/a>, which in turn brought the bank \u201ca surfeit of low-cost deposits\u201d from start-ups \u201cin the technology, health care, and life sciences industries.\u201d<\/p>\n

When the new industry-wide exemption went into effect in October 2020, SVB grew more emboldened to expand before\u00a0running into headwinds<\/a> in 2022, as deposits and asset valuations shrank as the Fed hiked interest rates. But the bank\u2019s illiquid funds could stay on the books, managers noted, thanks to the Fed\u2019s light-touch approach to venture capital assets.<\/p>\n

\u201cAs a result of various subsequent amendments to the Volcker Rule,\u201d SVB wrote last year, \u201cwe believe that substantially all of our Restricted Volcker Investments (i) qualify for new exclusions under the amended rules, (ii) otherwise are excluded from the definition of \u2018covered fund\u2019 or (iii) commenced or completed a liquidation or dissolution process prior to July 2022.\u201d<\/p>\n

The firm noted that these amendments included \u201cthe adoption of new exclusions from the definition of \u2018covered fund\u2019 for venture capital funds and credit funds.\u201d<\/p>\n

But all of these investments were inherently highly risky, because stakes in start-up companies can\u2019t easily be sold, unlike shares in publicly traded companies.<\/p>\n

In another excerpt from the report discussing the Volcker Rule, SVB explained that their VC investments are illiquid. The bank said that it makes \u201ccommitments to invest in venture capital and private equity funds, which in turn make investments generally in, or in some cases make loans to, privately-held companies\u201d and that the money typically can\u2019t be withdrawn for years.<\/p>\n

\u201cCommitments to invest in these funds are generally made for a 10-year period from the inception of the fund,\u201d the company said. \u201cAlthough the limited partnership agreements governing these investments typically do not restrict the general partners from calling 100 percent of committed capital in one year, it is customary for these funds to generally call most of the capital commitments over 5 to 7 years.\u201d<\/p>\n

To make matters more volatile, Silicon Valley Bank\u2019s loan portfolio was highly concentrated. The bank disclosed that \u201ca significant portion of our loan portfolio is comprised of larger loans,\u201d including \u201ccredit to our private equity and venture capital clients,\u201d and that these lines of credit \u201ccould increase the impact on us of any single borrower default.\u201d<\/p>\n

\u201cAs of December 31, 2022, loans equal to or greater than $20 million to any single client (individually or in the aggregate) totaled $46.8 billion, or 63 percent of our portfolio,\u201d the annual report read.<\/p>\n

Sure enough, SVB\u2019s investment strategy began to falter in the second quarter of 2022. As the Fed hiked interest rates and\u00a0VC activity ebbed<\/a>, the bank\u2019s cash flow reversed, leading to a steady stream of depositors fleeing the institution throughout the year.<\/p>\n

The exodus eventually prompted the bank to sell off\u00a0$21 billion<\/a>\u00a0in bonds at a loss, which led managers last Wednesday to seek private funding to stay solvent. A sharp increase in withdrawal requests followed on Thursday, causing a run on deposits. By Friday, SVB failed, and regulators took control of the firm.<\/p>\n

The crash created a panic among Silicon Valley tech investors: the Federal Deposit Insurance Corporation only insures up to $250,000 in each customer\u2019s deposits, and it turned out that more than 90 percent<\/a>\u00a0of SVB\u2019s deposits were uninsured at the end of 2022.<\/p>\n

Some of those depositors threw\u00a0fits on social media<\/a> over the weekend after regulators said that uninsured depositors would have to wait for SVB assets to be liquidated before they could start recovering their money. On Sunday, the Fed and other regulatory agencies announced extraordinary measures, guaranteeing those uninsured deposits independent of the outcome of the SVB fire sale.<\/p>\n

But if it weren\u2019t for the Fed itself granting SVB an exemption to the Volcker Rule, the trajectory of the bank might have looked very different, according to the former congressional aide who helped draft the Dodd-Frank financial reform law.<\/p>\n

\u201cWe know Silicon Valley Bank was extraordinarily unique in that it grew very rapidly over the last several years, fueled in part by fickle corporate deposits from venture capital\u2013related companies,\u201d said the ex-staffer. \u201cWe also know that it invested those in very long-dated, very low-interest bearing debt securities that lost significant value when the Fed hiked rates. And we know that Silicon Valley Bank had a significant amount of private fund exposure courtesy of the Fed\u2019s slow implementation of the Volcker Rule and its decision to grant the bank an exemption.\u201d<\/p>\n

The ex-staffer noted that he was personally lobbied by Silicon Valley Bank on a Volcker Rule exemption as the firm led industry efforts to shield venture capital from the effects of the regulation.<\/p>\n

Another expert who spoke to the\u00a0Lever<\/em>\u00a0agreed with the ex-staffer\u2019s assertion that the exemption needed to be examined.<\/p>\n

\u201cYes, that\u2019s certainly a piece of the puzzle,\u201d said Bartlett Naylor, financial policy advocate for the nonprofit consumer advocacy organization Public Citizen. Naylor noted that SVB had been lobbying to weaken the Volcker Rule since 2010, the year Congress passed the Dodd-Frank financial reforms. Other relevant factors, Naylor said, include the Dodd-Frank rollback passed by Congress in 2018, which subjected banks like SVB to less stringent oversight<\/a>, and the Fed\u2019s decision to weaken liquidity rules for banks with fewer than $700 billion assets. He noted that Silicon Valley Bank pushed for both of these outcomes.<\/p>\n\n \n \n \n\n \n \n

You can subscribe to David Sirota\u2019s investigative journalism project, the\u00a0Lever<\/i>, here<\/a>.<\/p>\n\n\n\n

This post was originally published on Jacobin<\/a>. <\/p>","protected":false},"excerpt":{"rendered":"

In the years before Silicon Valley Bank (SVB)\u2019s sudden failure, federal regulators gave the firm a special exemption from rules designed to prevent deposit-taking banks from engaging in risky investments and financial speculation, according to records reviewed by the\u00a0Lever. The move \u2014 which was a precursor to regulators later extending a similar exemption to the [\u2026]<\/p>\n","protected":false},"author":1988,"featured_media":0,"comment_status":"closed","ping_status":"closed","sticky":false,"template":"","format":"standard","meta":{"footnotes":""},"categories":[],"tags":[],"_links":{"self":[{"href":"https:\/\/radiofree.asia\/wp-json\/wp\/v2\/posts\/1026211"}],"collection":[{"href":"https:\/\/radiofree.asia\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/radiofree.asia\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/radiofree.asia\/wp-json\/wp\/v2\/users\/1988"}],"replies":[{"embeddable":true,"href":"https:\/\/radiofree.asia\/wp-json\/wp\/v2\/comments?post=1026211"}],"version-history":[{"count":1,"href":"https:\/\/radiofree.asia\/wp-json\/wp\/v2\/posts\/1026211\/revisions"}],"predecessor-version":[{"id":1026212,"href":"https:\/\/radiofree.asia\/wp-json\/wp\/v2\/posts\/1026211\/revisions\/1026212"}],"wp:attachment":[{"href":"https:\/\/radiofree.asia\/wp-json\/wp\/v2\/media?parent=1026211"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/radiofree.asia\/wp-json\/wp\/v2\/categories?post=1026211"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/radiofree.asia\/wp-json\/wp\/v2\/tags?post=1026211"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}