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I'm going to use this text, posted in last week's thread, as a jumping off point to make a little effortpost on a boring area that's actually kind of important, and where I know a little bit: treasury management!
This will only happen if your CFO is incompetent and doesn't do treasury management.
Treasury management - the most basic practice of any corporate finance department - is the practice of managing corporate cash in order to earn interest on what isn't being used , ensure that whatever cash is needed by the business is available, and also minimize tail risks like your bank going belly up.
Step 1 is observing that you can get 4.5% on 4 week treasuries. These are, regardless of amount, backed by full faith and credit of US Gov.
Now suppose you are a business with $500k of biweekly expenses ($500k due on Mar 15, $500k due on Mar 31). You have $20M in venture capital remaining which gives you about 1 year 8 months of runway.
All of that - minus $500k or so needed for short term investments - goes into 4-8 week treasuries which you reinvest whenever they mature. This earns 4.5% or about $900k/year in essentially free money. Money sitting in government bonds with duration < 90 days is called cash equivalent by corporate finance people.
Your not incompetent CFO just extended your runway to 1 year 9 months.
Step 2: ensure that the maturity dates of these cash equivalents line up to your payroll dates. $500k cash is due on Mar 15 for payroll/etc. Fortunately, $500k worth of your 4 week treasuries got turned into cash on Mar 9 (typically the maturity date is thurs).
Another $500k cash is due on Mar 31. You have another $500k worth of 4 week treasuries maturing into your bank account on Mar 30 (a thurs) or maybe Mar 23 (also a thurs) if you really want to be safe.
Step 3: line up a short term credit facility.
Some expenses are less predictable. Part of the job of CFO is to project these expenses, come up with upper bounds, and inform the CEO what it will cost if these bounds are exceeded. Then the CFO goes to a few banks and lines up credit facilities - a $2-3M line of short term credit backed by cash equivalents from step 2.
Step 4: have a few bank accounts including one at a "too big to fail".
That's treasury management, obviously oversimplified.
Now suppose your CFO actually did his job. It's Mar 13 and SVB just imploded. You had $500k sitting in SVB for Mar 15 payroll and that's locked up. Here's what you do:
Mar 11: Quickly call up your credit facility and tell them to wire $500k to your payroll provider on Mon. Call your payroll provider and tell them to confirm with the bank that this is happening to avoid any snafus.
Mar 13-14: As soon as SVB allows it, wire the $250k FDIC insured money to your credit facility. Also redirect treasury maturity payments to said account, and take another $250-270k of cash equivalent and don't reinvest them.
Mar 16 or Mar 23 (a thursday when your maturity payment gets deposited): get $270k worth of 4 week treasury maturity payments from the US govt. Wire this money back to your credit facility.
Net result is that you make payroll with no interruption. You just lost $250k to SVB's errors and paid your credit facility $20k in interest. The end.
There are services that help automate treasury management for smaller companies now, like Vesto.
Until last year T-Bills were paying ~nothing, and it had been that way since 2008, an eternity in the startup world. There was no direct financial incentive to do anything more complicated than park your money in a checking account. Sure, ideally everyone should have been actively managing things to hedge against bank failure, but startups have a zillion things to worry about. SVB's pitch was basically that they were experts on startup finance and would relieve you of having to worry about this yourself. The social proof of these claims was impeccable.
So, yes, many startups screwed up. It turns out that safeguarding $20M isn't entirely trivial. But it's a very predictable sort of screwup. There wasn't really anyone within their world telling them this, it wasn't part of the culture, nobody knew anyone who had been burned by it.
And, well, maybe it should be trivial to safeguard $20M? "You have to actively manage your money or there's a small chance it might disappear" is actually a pretty undesirable property for a banking system to have. The fact that it's true in the first place is a consequence of an interlocking set of government policies — the Fed doesn't allow "narrow banks" (banks that just hold your money in their Fed master accounts rather than doing anything complicated with it) and offers no central bank digital currency (so the only way to hold cash that's a direct liability of the government is to hold actual physical bills). Meanwhile the FDIC only guarantees coverage of up to $250K, a trivial amount by the standards of a business.
The net result of these policies is that the government is effectively saying "If you want to hold dollars in a practical liquid form you have to hold them in a commercial bank. We require that bank to engage in activities that carry some level of risk. We'll try to regulate that bank to make sure it doesn't blow up, but if we fail, that's your problem."
"WTF?" is a reasonable response to this state of affairs. If these companies had had the option to put their money into a narrow bank or hold it as a direct liability of the government, but had nonetheless chosen to trust it to a private bank because they were chasing higher returns, I'd have zero sympathy for them. But our system declines to make those safer options available.
They could have put their money in larger more diversified bank subject to more regulations including liquidity stress tests that SVB successfully lobbied to be exempted from. The VC world and their startups weren't seeking maximum safety and unfairly barred from seeking it. They sought out a smaller bank with less regulatory oversight that specialized in their industry presumably because that offered benefits.
Greg Mankiw says that the stress tests probably wouldn't have caught this, although I imagine that they'll be modified to cover this scenario in the future.
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Would those stress tests actually detect any issues, or would SVB have been fine either way, with or without the changes they lobbied for? Has anyone actually checked that, or is this just an empty pro-government regulation talking point?
I am not an expert on how the Dodd Frank Act Stress Test is conducted and I don't know whether it would have caught this. Forbes says that "will we get fucked if the fed raises rates" is a basic scenario they should have been testing for and that they were exempt from disclosing whether they had enough high quality liquid assets to cover 30 days of distressed cash flow. I don't know whether the standard definition of distressed cash flow includes this sort of bank run. I suspect someone who is an expert on all this will do a big analysis in the next week or so.
I'm suggesting that the VC & startups were not maximally risk averse in their banking selection. Even if you think regulation adds no security, "hey let's put all our money in a bank specializing in one industry" seems obviously more risky than "let's deposit in a massive diversified bank like BoA. The idea that because The Narrow Bank was shut down they had no safer option than SVB doesn't make much sense to me.
https://www.google.com/amp/s/www.forbes.com/sites/mayrarodriguezvalladares/2023/03/11/warning-signals-about-silicon-valley-bank-were-all-around-us/amp/
The burden of proof is on people calling for regulation and complaining about SVB lobbying to actually show that the stress tests they were allegedly exempt of would actually have prevented the situation. Otherwise, this is just pure partisanship without any substance: if you claim the problem here is lack of regulation and stress test, you better show that what you propose is more than empty quasi-religious ritual to appease the regulation gods, and that it would actually causally achieve substantial outcome.
+1
Elizabeth Warren sent up her offering the regulations Gods in this morning's NYT.
Which also means she had her staff write the op-ed over the weekend. What a great boss.
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Since when have banks been banned from owning Tbills? They can 100% hold safe cash like instruments that can be liquidated quickly.
The phrase "Narrow Bank" is the name of an actual bank that the Fed shut down because it did not lend out money and just held 100% safe reserves.
https://archive.is/TqCJX
The issue there is more that the Fed pays interest on excess reserves and that bank was just trying to abuse that system. The fact they could abuse it shows how much of an abomination the whole reserves system has become; but, I don't think an actual 100% reserves bank that just held required reserves at the Fed and kept the rest in T-bills or money in its own vaults would get in trouble.
No, the explicit reasoning of the fed in blocking TNB is that it would discourage people from putting money into institutions that lend.
To be explicit, the Fed Reverse's refusal (and later notice of rulemaking) was about The Narrow Bank (and other) being able to access the interest on excess reserve rate accounts (possibly only at full rate? I can't find the final rule, if there ever was one). The Narrow Bank was chartered in Connecticut and still has a cert good til August of 2023, though I think their specific business model is focused very heavily on those rates and thus they haven't opened for accounts yet.
((I expect groups like the Narrow Bank and Custodia are probably more about the philosophical point, anyway.))
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That is not at all my interpretation of the Fed's statement. I read it as more in line with my interpretation. They explicitly state many times in their statement that the issue is over what institutions should receive interest on reserves. If The Narrow Bank did not receive interest on reserves the Fed wouldn't care IMO. The article in the archive link above also explicitly makes note that The Narrow Bank was trying to do arbitrage on the Fed's policy of paying interest on reserves. I think you are just mistaken.
Nah it really must be more ideological, or something else like that. To the extent any journalist or economist was speculating that the Fed wants to avoid paying interest on excess reserves, they would be flatly incorrect. Central bank reserves are a closed system, so to the extent that a narrow bank is attracting them, that's just a flow from other banks where they were beforehand. The central bank is paying the same interest out either way. Other non-depository institutions (who aren't eligible for IOR) using reverse-repos to get (nearly) the base interest rate is just a workaround to help smooth out the system (ineligible because of congressional rules; the central bank would almost certainly prefer to pay it out in as simple a fashion as possible).
And the central bank is not trying to avoid paying out interest -- it's a policy choice in the first place to pay IOR (that's the whole rate maintenance regime now: instead of using open-market-operations to maintain a positive interest rate, they simply flood the system with excess reserves and pay interest on them directly, which is way simpler). It sounds like the Fed had been narrowing the gap between ceiling and floor rates anyway, because they never were using that lower rate to try to really save money or whatever.
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How do you allow a narrow bank without collapsing the entire banking system? Once you can put your cash in a place that has no risks aside from actual fraud and sovereign default, why would you put it anywhere else? And if you won't put it anywhere else, how do private loans get made? This is made worse by the fact that a narrow bank today would pay more than savings, but even if a narrow bank paid zero, the fact that the risk was literally as close to zero as possible would likely result in most commercial bank deposits vanishing, and then who would make loans?
In ye olden times also known as "the late 80s", it was common (at least in Northern Europe) for bank accounts to pay actual interest, particularly for fixed term deposits. This would be that same thing expect instead of a fixed term, the depositer would be taking some minor risk in exhange for return on their deposit. Fully guaranteed accounts might in turn pay no or even a small negative interest (eg. you have to pay an annual fee for the bank to safeguard your money).
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Commercial banks could offer higher interest rates on deposits, lend out their own capital, or issue bonds. If this didn't provide sufficient funding for whatever amount of lending the government wanted to see, the government itself could loan money to banks to re-lend.
Really though, the easiest patch to the system would just be for FDIC insurance to (officially) cover unlimited balances, or at least scale high enough that only the largest organizations had to worry about it. It makes no sense to require millions of entities (if you include individuals of moderate net worth) to constantly juggle funds to guard against a very small chance of a catastrophic outcome that most of them aren't well positioned to evaluate the probability of. That's exactly the sort of risk insurance is for.
If the concern is that this will create moral hazard because banks that take more risks will be able to pay higher interest rates and fully-insured depositors will have no reason to avoid them, the solution is just for regulators to limit depository institutions to only taking on risks the government is comfortable insuring against. Individuals should be allowed to take on risk to chase returns, but there's no compelling reason to offer this sort of exposure through deposit accounts in particular. Doing so runs contrary to the way most people mentally model them or wish to use them.
This results in a fully socialized lending system with the government making all the decisions. Which is likely where we're headed ANYWAY, I'll grant, but it seems like a bad end.
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Why not require banks to buy insurance instead of government regulation? Get market pricing on risks instead of government fiat?
Insurance is a key if not the main function of the US government and many other governments. They can print money. There’s no insurance company big enough to insure. SVB. Maybe a consortium could also insure a little. But the insurance industry is not bigger than the banking industry. They couldn’t insure a bank issue that is systematic with multiple failing. You would move the stystematic risks for bank failure to banks failure causing insurance failure. AIG had a quant insurance unit that insured some financial risks and surprise surprise they sold it too cheap and blew up.
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Forcing banks to buy insurance still is government regulation.
Yes it is. I should’ve made it clear. One is command and control (ie you must do XYZ). Think old school environmental regulation. The second is more like a carbon tax. It regulates via pricing arguably allowing a more accurate risk.
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Who are you going to buy global financial collapse insurance from? What counterparty can be relied on to pay out in such a scenario?
You gotta have physical. Physical gold, yes. But also physical land you can reach, physical guns, and a physical body of followers you can trust.
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In the case of global financial collapse the dollar is probably worthless so who cares?
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Even a small yield on things like private loans would be worth it for larger sums. I'm sure that there's a certain subset of business that would take 0% yield for 0% risk, but I don't think that's everyone.
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I'd imagine the banks that make money off your deposits would actually have to give you a cut of the pie as enticement. And really, why shouldn't they?
In theory. But in practice the federal government bails out “risky banks” so question is whether there is much juice to be squeezed.
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Wouldn't banks just increase their interest rate to attract depositors? It's self correcting: some people would choose the least risky option, their money would no longer be available for risky investments, and so the remaining people with less risk aversion would get greater returns.
I think risk aversion is strong enough that the banks would not be able to increase their interest rates sufficiently while still loaning money profitably. That is, fractional reserve banking (and thus the whole financial system) is based on fooling people into taking more risk than they'd like.
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