Name: Future of Finance 2024: The Future of Banking After Silicon Valley Bank
Uploaded: 2024-05-16
Duration: 9 min 59 s
Description: Tomasz Piskorski, Edward S. Gordon Professor of Real Estate, Finance Division, Columbia Business School

Tomasz Piskorski, Edward S. Gordon Professor of Real Estate, Finance Division, Columbia Business School

Future of Finance 2024: The Future of Banking After Silicon Valley Bank

Conferences

Uh Welcome everybody. Glad to be here. I'm a professor at Columbia Business School. I do a lot of work on financial intermediation, banking, fintech, and real estate. And recently, along with my colleagues, I've done quite a lot of work on uh financial stability and drawing lessons from the recent bank failures such as the Silicon Valley Bank. I would like to tell you a little bit about. So let me tell you our view. What we think is one of the main sources of risk currently in the US financial system. From our perspective, it's really the fact that banks have very high leverage if you look on AAA typical bank in the United States. And there is really very little variation whether you're a small bank, whether you're a large bank, banks are essentially about 90% debt funded and only 10% of equity. So think about what it means. Consider, for example, a situation when there is a modest decline in the value of bank assets, let's say 10% that already potentially put these institutions at the brink of insolvency because the value of the assets will be less than the face value of the liabilities. And if you look on the banking sector as a whole, you know, this is a $24 trillion of assets on the asset side, banks take a lot of duration risk and credit risk. They give a lot of assets like securities, long term treasuries, long term mortgage backed securities. On the. In addition, they have real estate loans including commercial real estate loans and other, you know, loans like corporate loans with the credit risk and the way they finance it is essentially with short term debt. Most of these debts are deposits about 18 trillion of them and about half are insured by the ac and half are uninsured. These are deposits above $250,000. And in addition to that, the banks have fairly thin equity C So you can see this is a pretty uh fragile system with very little equity financing and a lot of debt financing. And in that sense, the recent monetary tightening illustrates this point. The fed raised interest rates very aggressively and essentially in a matter of a year, they went from 0 to 5% what it means to the value of long duration assets. There has been a very big decline in the value including us treasuries and so on. If you look on long duration assets, long term bonds, they decline by, you know, in the order of 30%. So when you take this decline, the market implied decline in the value of assets and applied to bank balance sheets. What you will find is that in the aggregate, the value of the bank assets right now is about $2 trillion less relative to where it was at the beginning of the fed tightening cycle. And in fact, there's quite a few banks in the US right now and Silicon Valley Bank was one of them, but currently have the value of the assets. The market value being less than the face value of the debt. So in principle, if the depositors would show up, this bank would fail unless of course regulators step in. Now, I'm not trying to say that all these banks will fail. It depends on your funding and in particular, it depends what portion of your funding is unstable, especially uninsured deposits because uninsured depositors can lose money if the banks fail. And you know, in that sense, you know, the Silicon Valley Bank was an outlier that 80% of its assets were financed with uninsured deposit. Essentially Silicon Valley Bank had just uninsured deposit funding. So it is very fragile in that sense. And the question is, you know, and the mechanisms as follows, you know, the interest rates go up, you can add to this credit risk. Bank asset values decline like they did and ensure depositors get spoke, they see the big declines in asset values, they worry about solvency of the bank, they start withdrawing money and then you can end up with a run equilibrium. The key question and I was talking a lot with regulators about that is. How special is the Silicon Valley Bank? Are there other banks like that? And the short answer is yes, there is quite a few banks in the United States right now. They have very similar risk characteristics, not as extreme as Silicon Valley Bank, but you can support a run on them. They are actually at the risk of run and this is just the duration effect if you add to discredit risk. Remember that for a mid size banks, about 25 to 40% of the assets are commercial real estate loans. With that analysis loan by loan, 14% of these loans are underwater, meaning the property value is less worth less currently than the face value of debt. If you look on office loans, it's 44%. So in addition to this duration risk, there is also a credit risk that will enlarge the set of banks that could potentially fail. So the obvious question is, and you know, talking all the time with this with regulators, you know what to do about it. And one natural answer is well, let's raise the bank capital requirements. Maybe not right now. Once the things come down a bit that would make the system more safe. But the obvious question is how much leverage financial institutions really need to provide efficient functions like originating clowns and doing other things. And in fact, we have a window in it. We compare the leverage of banks to non bank lenders. The black curve shows you the non bank lenders. These are the institutions that make loans like banks. This is in the mortgage market, but don't have access to ensure deposit funding and are lightly regulated. And guess what in this private market benchmark without access to insured deposit funding, these institutions have much less leverage and much more equity funding. And the lesson we draw from this, you can be a pretty good lender with much lower leverage. And what's interesting is the biggest discrepancy is actually for smaller and mid size banks. What it means is, let's say the JP Morgan, they leverage is pretty close to what they would have been leverage even if they wouldn't have access to ensure deposit funding. It's precisely the smaller and mid size banks including banks like Silicon Valley Bank that were leverage much more. And because of this implicit and explicit guarantees, you know, Silicon Valley Bank did not have much inured deposit funding, but there was a lot of other banks that do and take advantage of that. One. Of course think is that, you know, if you talk to uh uh bank CEO S, they will tell you, hey, if you raise bank capital requirements, the landing will collapse and we want to have contraction of economic activity. We just really cannot do it. Of course, the answer to this question depends on how important are banks in financing credit to households and firms. And let me just tell you they are not as important as commonly thought in the 19 seventies, bank balance sheets financed 60% of lending to households and films. So in other words, in the 19 seventies, banks were very important. Nowadays, bank finance only about a third of credit to house consent. The the rest is finance with debt, securities, private credit and so on and so forth. So in the aggregate, the banks are much less important than they were a few decades ago. And what it means, it has interesting implications for capital regulation. What would happen? We actually did a simulation if you would raise capital requirements on us banks. Well, the amount of bank balance sheet lending will drop substantially and so is the bank profit. So you know, it's kind of understandable why some bank CEO S might not like it. But the aggregate decline in lending would actually be quite modest. What would simply happen, bank would still make loans, but instead of keeping them on balance sheet, they would sell them and there will be expansion of non bank and private credit. So let me just conclude with some thoughts where I'm thinking it will go going forward first, I think the banks are continue to become increasingly less relevant and especially smaller and mid sized banks. We have ongoing consolidation in the banking industry, I predict in a few years, we'll have much fewer smaller and mid size banks. I also think that we will see a growing rise of debt, securities and private credit, private credit is rapidly increasing right now. And of course, we are going to finance a lot of debt, you know, vehicles like money market, funds, exchange traded funds and so on. On the asset side, the traditional banks already lost a lot of edge think about the mortgage finance, which is a very important debt market. Now, banks account for less than half of the lending there. And the biggest lender is quicken loan, no quicken loans currently called rocket mortgage. You know, they just have, you know, the platform, they don't have deposits. It's a non bank and you know, impact of A I is likely to make things potentially worse for banks. As we just heard a little bit in the recession, I expect this non bank financial institutions to possibly be more able to innovate in this space especially because they are more lightly regulated. And so essentially the main value the banks currently derive is on the liability side is this access to ensure deposit funding allows this cheap debt, they can recycle into loans but also in securities on other vehicles. So in some ways, survival of especially mid size and smaller banks critically depends on continued access to this implicit and explicit subsidies. And if the regulators decide to crack it down, we will see further contraction of smaller and mid-sized banks. Bigger banks of course, will have to innovate harder and harder to stay relevant, but they have a scale. So they probably will be able to uh to continue operating. And the last thing even on the liability side, there are many innovations with threatened bank. Think about central bank, digital currency or alternative payment systems. If this takes the deposit role from the banks, they will be really in a precarious state because you know, on the asset side, it is already very difficult for them to make money. Once they lose the deposit advantages, it will be a difficult position for them. So thank you very much and thanks for your attention.