The recent highly publicized collapses of Silicon Valley Bank (SVB) and Signature Bank serve to highlight the considerably less risky business models of the local banks in and around Southwest Washington. They also bring into focus some of the regulatory and governmental steps that may, or may not, help matters.
No dominos here
The high-profile bank failures have not made people less trusting of banks in general, said Kevin J. Lycklama, president and chief executive officer of Riverview Bank.
“I don’t believe the general public has lost trust in local banks,” he said. “The recent closure of Silicon Valley Bank and Signature Bank highlighted the value of working with a community bank that is invested in the local community. The banking system remains healthy and strong. Banks hold higher levels of capital and liquidity than in the past. Credit quality and the local economy are also both strong.”
There are always outlier banks that have chosen to leverage their capital and go for a high-risk, high-reward model, he maintained. “That is the opposite of what Riverview has done. We have always prioritized safety and soundness first, then profitability and finally growth.”
“We have not seen a domino effect at our bank,” said Neil Zick, president and CEO of Longview-based Twin City Bank. “We had a few questions from customers when the news first broke, but have not seen a significant movement in deposits.”
In fact, many community banks have lately gained customers that have concerns about riskier institutions, said Kathryn Swenson, president and CEO of the community bank advocacy group Community Bankers of Washington (CBW).
The recent collapses appeared to reflect a liquidity issue, according to Brian J. Adams, professor of finance at the University of Portland’s Pamplin School of Business. “Some banks did not effectively manage interest rate risk in their securities portfolio and deposits.”
Swenson stressed that depositors’ funds remain secure in community banks. “These institutions are vested in their communities, promoting financial stability and prosperity on Main Street. Recent developments illustrate the risks of large financial institutions over-concentrating their activities.”
SVB, which promised high interest rates and backed these up by increasingly investing in longer-term government bonds, was impacted when the Federal Reserve increased rates, noted Piman Limpaphayom, associate professor of finance at The School of Business, Portland State University. “Those bonds are supposed to be low risk, but the increase in interest rates has a negative impact on their values.” And once depositors started withdrawing in large numbers, the writing was on the wall. “No bank can sustain a 15%-20% immediate withdrawal of deposits,” Limpaphayom said.
Lycklama said most financial institutions’ investment portfolios do not exhibit the kinds of issues seen at SVB, which was over-concentrated in long-term securities. “Riverview has an average duration of less than five years on its investment portfolio, which significantly reduces the risk.”
The federal government’s decision in March to mitigate fallout by offering emergency lending to some depository institutions, through the Bank Term Funding Program (BTFP), is expected to support availability of credit in many communities, Swenson said. Nationwide, banks had tapped the BTFP for $64.4 billion through Wednesday, March 29, indicating that many are taking advantage of it, she pointed out.
The program offers loans of up to one year to eligible institutions pledging as collateral US Treasuries, agency debt and mortgage-backed securities, and other qualifying assets.
Lycklama said the federal program probably has no major impact locally. But he said it does provide an additional source of liquidity for banks to fund loans, if needed. “While this likely won’t have a significant impact, it does provide banks with another option to diversity their funding sources.”
Ao Wang, a visiting assistant professor in the business department of Washington State University Vancouver, welcomed the fact that the BTFP will improve liquidity for banks. “It is a nice tool to use if necessary, though some banks might worry that it will send a negative signal to the public if they use the program.”
Adams described the federal moves as “the same playbook” as was used during financial crisis conditions in 2008-2009: “allow banks to borrow against their best assets to buy them time to better manage their interest rate risk.”
The recent failures are a reminder that while big banks are under federal scrutiny, smaller ones have a state-scrutiny situation – in part because of a change in federal regulations five years ago. The 2010 Dodd–Frank Wall Street Reform and Consumer Protection Act requires banks above a certain amount of assets to undergo scrutiny – the “stress test” to ascertain how capital ratios would withstand macroeconomic hardship. But a 2018 amendment raised the threshold for this to $250 billion in assets from $50 billion.
“All local institutions in Washington are under $250 billion,” Limpaphayom said. “They are under the radar for Dodd-Frank, so the state supervision becomes very important as added security.” While there has lately been talk of trying to tighten up the Dodd Frank regulations again, it is not clear whether this would pass.
If the Federal Reserve were to respond to recent developments by tightening up capital reserve and liquidity requirements for financial institutions, this would have a negative effect on the local economy, Zick warned. “Raising interest rates slows demand for loans and then causes less expansion,” he said.
Similarly, Lycklama argued that such steps by the Fed would lower the amount of money that banks have to invest in the local economy. “Community banks support local businesses by making loans to fund real estate purchases, equipment financing, operating lines of credit as well as funding residential home purchases and consumer loans.”
Wang also said the local economy would suffer from the Fed potentially tightening up requirements. “Banks would have less flexibility to issue loans and have to increase their loan application standards because they can bear less default on loans.”
Swenson said that CBW is focused on ensuring that federal, state, and local response to the closures at SVB and Signature Bank does not affect the community banks. “Community banks have long supported tiered regulations for different financial institutions,” she said.
Adams said that there is something to be said for applying the stress test to smaller banks. “Capital adequacy and reserve regulations were not the cause of the current issue. However, we could benefit from a discussion of how to more quickly identify bank balance sheets’ susceptibility to liquidity runs. We should think about how to implement stress test requirements on smaller banks.”
Lycklama said Riverview Bank has not seen a large outflow of deposits. “Customers recognize the differences in the banking models from these banks,” he said. “Silicon Valley Bank and Signature Bank had uninsured deposits greater than 90%. Riverview’s uninsured deposits are approximately 18%. These banks also had a high concentration of their deposits in high-risk industries such as venture capitalists, startups, tech companies and crypto. Riverview operates a relationship-based business model that emphasizes strong diversity in our customer base.”
He also said Riverview has worked with its customers to educate them on FDIC insurance. “No depositor has ever lost a penny in FDIC insured accounts since 1933,” he said. “Our bankers are highly trained and can work with customers to provide higher levels of FDIC insurance on their accounts. At Riverview, we also have products that can provide both consumer and business accounts with up to $250 million in FDIC insurance.”
Swenson also stressed the security aspect of community bank deposits. “Very few — if any — community banks hold significant amounts of uninsured deposits. Consumers and small-business owners like community banks’ relationship-based business model, as well as the stability these institutions have had in their local communities for decades.”
Adams pointed out that the more than 90% level of uninsured deposits at SVB meant the bank had fewer depositors depositing more money in their bank. “It only takes a few depositors withdrawing their money to start causing a liquidity crunch for a bank with that level of uninsured deposits.”
Downgrades aren’t for everyone
As for the decisions by the credit rating agency Moody’s Investors Service to downgrade its outlook on the US banking system to negative, and downgrade the credit ratings of several regional banks, Zick said the affected institutions are entirely different from community banks like Twin City Bank. “Our business model as a community bank is different than the regional banks,” he said. “Community banks, because of our relationships with our customers, do not experience the same issues as the larger regional banks. Most community banks are very strong.”
Swenson expressed similar thoughts. “Community banks are vastly different from the nation’s largest and riskiest banks, and they remain healthy and vibrant,” she said. “This long-term outlook ensures a tight focus on established banking practices that promote safety and soundness over generations. As reported in the FDIC’s latest Quarterly Banking Profile, community banks’ asset quality is favorable, total deposits are stable, and capital ratios remain strong.”
The Moody’s downgrades “may create some fear but will not have long-term negative effects,” Wang predicted.
Lycklama said the one possible effect of the rating shift, for local banks, may be to give them a competitive advantage over larger and riskier banks. “Deposits that remain at community banks also benefit the local economy by providing more availability to support loan growth to small businesses and consumers in our communities.”
Business may slow
Any hypothetical possibility that the recent situation will cause pressures on the banking sector that will slow real estate development, because of a possible reduction in the available financing, has not been seen in practice thus far, Lycklama said. “If deposits shrink or are pulled out of banks, or regulators place higher capital and liquidity restrictions on banks, it reduces the amount of money banks have to lend out. Either of these situations could reduce the availability of financing for loans and increase borrowing costs. As of now that has not happened. Riverview continues to lend at full capacity and is actively looking for new lending opportunities.”
There has been some concern that if the liquidity crunch continues in the longer term, the result could be tighter commercial and consumer credit, Adams said.
“Community banks serve customers in good times and bad, and will continue to help customers through this inflationary period,” Swenson said. “We do not anticipate any slowdown in credit availability at community banks. I wouldn’t say it’s quite business as usual, but we haven’t seen credit contraction or a large outflow of deposits following Silicon Valley Bank’s failure.”
More regulations unnecessary
The recent events do not indicate that banking needs more regulations, Zick said. “I think the regulators should have known that the failed banks were having a problem,” he said.
Regulations do not need to be changed in reaction to the news, Adams also said. “The overexposure to risk in this situation is interest rate risk, not credit risk. There are effective ways for banks to manage their interest rate risk. The increased cost of lowering interest rate risk would shrink bank profits. I guess some banks may not have wanted to lower their profit margins.”
Lycklama said there is no need to change existing regulations at the community bank level. “Community banks are very highly regulated and have many safeguards in place. These recent bank failures were outlier events. Those banks do not represent the banking industry as a whole and more specifically do not represent the local community banks.”
Swenson said CBW is fighting to ensure community banks “are not penalized for the actions of the largest and riskiest banks.” She said this means community banks should not bear financial responsibility for large bank speculators. “They should be exempt from restoring any potential losses to the Deposit Insurance Fund through a special assessment to cover systemically risky institutions’ uninsured depositors. The White House has called on the FDIC to exempt community banks from a special assessment, and FDIC Chairman Martin Gruenberg has confirmed the FDIC has that authority and is exploring an exemption. Small lenders shouldn’t have to pay for the mistakes of banks that are orders of magnitude larger with markedly different risk profiles.”
Wang said she was glad that the Federal Reserve took action to protect depositors. “This could strengthen the public’s confidence in the banking system. However, they do not want banks to have the impression that the Fed will have their back. So, the Fed sent out this message that banks are allowed to fail. I think this would urge banks to keep a closer eye on their management and portfolio.”