13 March 2023

We must not learn the wrong lessons from the Silicon Valley Bank collapse

By Laurence Smith

News that HSBC has agreed to buy the UK arm of the now defunct Silicon Valley Bank (SVB) is a welcome start to the week. The taxpayer has got off without paying a penny and depositors have been protected, meaning the threat of a clutch of promising British tech firms going under has been averted.

But even though a buyer has now come forward, this saga will leave the Bank of England and the City of London more broadly with plenty of lessons to learn. For years to come the failure of SVB and the response of both the FDIC in the US and the Bank of England will be matters of intense debate.

As ever with the collapse of financial institutions, there will be a chorus of voices arguing for greater capital requirements, tighter and tougher regulation, and warning us away from ringfencing reforms. These are the wrong lessons to take from the resolution of SVB UK, which has been a good example of the City, firms and the Bank working in concert to deliver a decent solution.

What went on with the parent bank in the US is beyond the control of the Old Lady of Threadneedle. UK regulators and the Government can only legislate for and handle subsidiaries such as SVB UK. Larger firms would be subject to a Bail-In and are beyond the scope of the powers used for a firm like SVB UK. As such, the main lessons we have here are for domestics ‘mid-tier’ banks and the mid-tier subsidiaries of foreign firms with balance sheets below £25bn (branches of foreign firms are another discussion entirely)

It is in this space where, in a post-Brexit world, the City needs to remain a positive and attractive environment for mid-tiers and challenger banks. Learning the wrong lessons from SVB UK’s collapse – particularly indulging knee-jerk calls for higher capital requirements and tighter regulation – would do nothing for the UK tech sector and our waning levels of investment more generally. (Indeed, even The Guardian notes that the collapse of SVB in the US was unrelated to capitalisation levels and leverage ratios…)

There are, I think, three key lessons from this episode:

Lesson 1: MREL and greater capital requirements are not the answer. 

Requiring SVB UK to hold more capital would not have averted this crisis. Issuing Minimum Requirements for Own Funds and Eligible Liabilities (MREL) would have allowed the option for a Bail-In (discussed elsewhere on CapX by John Myers). MREL can be equity or a special type of debt banks issue which, as part of a Bail-In, are converted into equity to absorb losses. In effect, MREL can facilitate the recapitalisation of a failed bank without involving taxpayers’ money.

But the issuance of MREL is an expensive endeavour and can threaten to inhibit growth. Metro Bank required  relief on its issuance and MREL requirements, and EY has highlighted the threats to lending by challenger banks impacted by MREL requirements. Making firms like SVB UK – or indeed domestic challenger start-ups – issue MREL would threaten to strangle banking competition before it ever really gets going.

Lesson 2: An effective PSP is optimum, and firms ought to prepare this process well

The only reason HSBC was able to purchase SVB UK is because of the Private Sector Purchaser (PSP) process overseen by the Bank of England and Rothschilds. Here the role for regulations and the regulator is to assess and support firms in achieving particular ‘outcomes’ in the event of a resolution, and to do this ahead of any crisis as part of the Business As Usual period and as part of an ongoing regular schedule of regulator-firm engagement. Data rooms, and the ability to ‘onboard’ a firm like Rothschild & Co, reduces the barriers to successfully securing a buyer. Buyers get access to decent data for due diligence, and the investment advisory firm supports the sale effectively. 

Lesson 3: Outcome-based regulation should not mutate

The BoE and Prudential Regulation Authority should not prescribe but guide firms to understanding what the outcome looks like. It is up to firms to judge how they go about achieving these outcomes, and up to them to tailor what the processes and frameworks look like for their firm specifically. Take mid-tier and challenger banks in the UK as examples for one second: SVB UK’s client base is very different to depositors at Starling Bank.

This is not prescriptive, these are not rigid rules, and an over-reaction by way of introducing tighter PRA/BoE/FCA rules would not serve to increase this resilience. In fact, to do so would only further place mid-tier banks at a regulatory costs disadvantage versus the big firms, and potentially leave some otherwise safe and profitable mid-tier firms unviable.

To respond to this crisis of this firm by calling for more regulation, more MREL, more capital and tightening the screw on challenger banks is misguided. These suggestions won’t stop banks failing, just look at Jeremy Irons’ monologue at the end of Margin Call listing every banking crisis of the last 200 odd years. Indeed, an overextension of prescriptive and costly regulation will only choke-off the City right when supporting firms and investment has never been more vital.

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Laurence Smith spent two and a half years at the BoE working in its Resolution Directorate as an analyst focussed on US subsidiaries. Laurence now works as an Associate-Director in Recovery and Resolution Planning for one the UK’s largest global banks.

Columns are the author's own opinion and do not necessarily reflect the views of CapX.