On March 10, 2023 the California Department of Financial Protection and Innovation ("CDFPI") closed Silicon Valley Bank ("SVB"), a California chartered, non-member bank. The CDFPI placed SVB into receivership and appointed the Federal Deposit Insurance Corporation ("FDIC") as receiver. At the time, SVB was the largest bank failure in the history of the United States.1
Contemporaneous news reports indicated that in the week prior to being closed, SVB was subject to the increasing withdrawal of deposits leading to an old-fashioned "bank run."2 One factor cited in the bank run was the withdrawal of significant amounts of deposits by venture capital and private equity firms whose deposits had been required to be placed in SVB through covenants in SVB credit facilities to those firms.3 This practice by SVB of requiring certain deposits to be maintained to support credit obligations is a "tie" by the bank of one product to another product. While tying is often not permitted by banks, the tying of deposits to loans has generally been permitted as a tie of traditional bank products.4
Ultimately, the instability in the financial system caused by the failure of SVB (and the failure two days later of Signature Bank, a New York chartered, non-member bank) led to the invocation of the "systemic risk exception" by the FDIC, the Board of Governors of the Federal Reserve ("Federal Reserve") and the Secretary of the Treasury (the "Statement"), pursuant to which the FDIC would "fully protect[ ] all depositors."5 The Statement provided that any losses to the Depositors Insurance Fund ("DIF") to support uninsured depositors would be recovered through a special assessment on insured banks.6
One of the effects of the Statement was to fully repay the deposits of some of the venture capital and private equity firms whose actions may have helped lead to the bank run. Subsequently, the FDIC issued a proposal to assess insured banks to replenish the DIF from a potential US$20 billion loss from payments to uninsured depositors ("FDIC Proposal").7
While the effect of the payments to uninsured deposits will be addressed by the FDIC Proposal, the cause of the bank run due to tying has so far gone unaddressed. Below, we review whether a change to the tying provisions may mitigate the risk of future bank runs for banks that operate in similar ways to SVB.
Did SVB tie?
SVB was a significant provider of financial services to the technology industry.8 This relationship can be beneficial to both borrower and lender: for technology companies, it could mean that SVB had more expertise than other banks in understanding their business models and specific financial needs. This expertise led SVB to provide credit to many technology companies, venture capital and private equity firms.
SVB used its outsized presence in the industry to require certain borrowers to also use SVB for some, or all, of their other banking needs. This requirement obviously helped SVB: it was able to grow its non-lending businesses, especially its deposit base, without having to locate new clients. This was less beneficial to borrowers. While there is a certain amount of convenience for customers to have one bank provide all of their banking services, it is safer for customers to allocate their banking services among several different providers in case one is unavailable, fails or does not offer a specific kind of service.
Customer diligence is considered an important part of the financial system, in that it provides a separate view from regulators and financial analysts of a bank's health. When customer diligence is removed, regulators and others become concerned about "moral hazard," in that a potential brake on a bank's risk appetite is eliminated. Deposit insurance is considered a moral hazard, in that it eliminates the necessity for depositors to review the relative health of the bank holding their money up to the insured amounts of each account (generally US$250,000).
When SVB acted to tie its customers' receipt of banking services to the availability of their loans, it reduced the ability of those clients to risk manage their banks.
What are some examples of these ties?
We have some examples of the specific ties used by SVB through the public filings of some of its borrowers. For one borrower, SVB required that it:
Maintain their and all of their Subsidiaries' (other than Excluded Subsidiaries') operating and other deposit accounts, the Cash Collateral Account and securities/investment accounts with Bank and Bank's Affiliates and shall conduct all of their investments and foreign exchange transactions at or through Bank. Co-Borrowers agree that they will cause each of the Excluded Subsidiaries to maintain its operating and other deposit accounts and securities accounts with Bank and Bank's Affiliates, but only to the extent Co-Borrowers determine that there is no adverse impact to Co-Borrowers or such Excluded Subsidiary operationally or commercially to do so after consulting in good faith with Bank.9
Through this provision, the borrower would be required to hold all of the cash and securities of its and its subsidiaries (which for venture capital firms would include invested in companies) in accounts at SVB. It would also be required to make all of its investments and foreign exchange transactions through SVB (presumably to the extent that assisting in making such investments were permitted banking activities).
Another more straightforward example:
6.10 Operating Accounts. Other than with respect to the Borrower's deposit accounts maintained with [other bank] on the Closing Date, maintain the Borrower's and its Subsidiaries' primary domestic depository and operating accounts and securities accounts with the Administrative Agent, any Lender, or any Affiliate of the foregoing.10
Other examples include:
(a) Maintain all of its and all of its Subsidiaries' operating accounts, depository accounts and excess cash with Bank and Bank's Affiliates; provided, however, Foreign Subsidiaries of Borrower may maintain accounts outside of the United States with financial institutions other than Bank and Bank's Affiliates. In addition to the foregoing, Borrower, any Subsidiary of Borrower and any Guarantor shall obtain any business credit card exclusively from Bank."11
6.7 Operating Accounts.
(a) Maintain substantially all of its operating and other Deposit Accounts with Bank and Bank's Affiliates with the principal balances of all such operating and other Deposit Accounts transferred to Bank within ninety (90) days after the Effective Date.
(b) No later than January 15, 2013 and at all times thereafter, maintain the majority of its Securities Accounts and other investment accounts with SVB Asset Management and SVB Securities.12
6.6 Operating Accounts.
(a) Maintain substantially all its depository and operating accounts and securities accounts and all foreign exchange transactions with Bank and Bank's Affiliates.
(b) Provide Collateral Agent five (5) days prior written notice before establishing any Collateral Account at or with any bank or financial institution other than Collateral Agent or its Affiliates. In addition, for each Collateral Account that Borrower at any time maintains, Borrower shall cause the applicable bank or financial institution (other than Collateral Agent) at or with which any Collateral Account is maintained to execute and deliver a Control Agreement or other appropriate instrument with respect to such Collateral Account to perfect Collateral Agent's Lien in such Collateral Account in accordance with the terms hereunder, which Control Agreement may not be terminated without prior written consent of Collateral Agent. The provisions of the previous sentence shall not apply to (i) deposit accounts exclusively used for payroll, payroll taxes and other employee wage and benefit payments to or for the benefit of Borrower's employees and identified to Collateral Agent by Borrower as such and (ii) the Cash Collateral Account.13
How was SVB allowed to make borrowers use its other services as part of a loan?
Banks generally are not allowed to condition the availability or pricing of a credit transaction on a borrower committing to use the bank or an affiliate for unrelated services. This is called "tying", and it is considered a violation of anti-trust banking laws.
Section 106 of the Bank Holding Company Act Amendments of 1970 provided, in pertinent part, that:
A bank shall not in any manner extend credit, lease or sell property of any kind, or furnish any service, or fix or vary the consideration for any of the foregoing, on the condition or requirement
(1) that the customer shall obtain some additional credit, property, or service from such bank other than a loan, discount, deposit, or trust service;
(2) that the customer shall obtain some additional credit, property, or service from a bank holding company of such bank, or from any other subsidiary of such bank holding company;
(3) that the customer provide some additional credit, property, or service to such bank, other than those related to and usually provided in connection with a loan, discount, deposit, or trust service;
(4) that the customer provide some additional credit, property, or service to a bank holding company of such bank, or to any other subsidiary of such bank holding company; or
(5) that the customer shall not obtain some other credit, property, or service from a competitor of such bank, a bank holding company of such bank, or any subsidiary of such bank holding company, other than a condition or requirement that such bank shall reasonably impose in a credit transaction to assure the soundness of the credit.
The Federal Reserve implemented this provision in Regulation Y:
(a) Purpose. This section establishes exceptions to the anti-tying restrictions of section 106 of the Bank Holding Company Act Amendments of 1970 (12 U.S.C. 1971, 1972(1)). These exceptions are in addition to those in section 106. The section also restricts tying of electronic benefit transfer services by bank holding companies and their nonbank subsidiaries.
(b) Exceptions to statute. Subject to the limitations of paragraph (c) of this section, a bank may:
(1) Extension to affiliates of statutory exceptions preserving traditional banking relationships. Extend credit, lease or sell property of any kind, or furnish any service, or fix or vary the consideration for any of the foregoing, on the condition or requirement that a customer:
(i) Obtain a loan, discount, deposit, or trust service from an affiliate of the bank; or
(ii) Provide to an affiliate of the bank some additional credit, property, or service that the bank could require to be provided to itself pursuant to section 106(b)(1)(C) of the Bank Holding Company Act Amendments of 1970 (12 U.S.C. 1972(1)(C)).
(2) Safe harbor for combined-balance discounts. Vary the consideration for any product or package of products based on a customer's maintaining a combined minimum balance in certain products specified by the bank (eligible products), if:
(i) The bank offers deposits, and all such deposits are eligible products; and
(ii) Balances in deposits count at least as much as nondeposit products toward the minimum balance.
(3) Safe harbor for foreign transactions. Engage in any transaction with a customer if that customer is:
(i) A corporation, business, or other person (other than an individual) that:
(A) Is incorporated, chartered, or otherwise organized outside the United States; and
(B) Has its principal place of business outside the United States; or
(ii) An individual who is a citizen of a foreign country and is not resident in the United States.
(c) Limitations on exceptions. Any exception granted pursuant to this section shall terminate upon a finding by the Board that the arrangement is resulting in anti-competitive practices. The eligibility of a bank to operate under any exception granted pursuant to this section shall terminate upon a finding by the Board that its exercise of this authority is resulting in anti-competitive practices.
(d) Extension of statute to electronic benefit transfer services. A bank holding company or nonbank subsidiary of a bank holding company that provides electronic benefit transfer services shall be subject to the anti-tying restrictions applicable to such services set forth in section 7(i)(11) of the Food Stamp Act of 1977 (7 U.S.C. 2016(i)(11)).
(e) For purposes of this section, bank has the meaning given that term in section 106(a) of the Bank Holding Company Act Amendments of 1970 (12 U.S.C. 1971), but shall also include a United States branch, agency, or commercial lending company subsidiary of a foreign bank that is subject to section 106 pursuant to section 8(d) of the International Banking Act of 1978 (12 U.S.C. 3106(d)), and any company made subject to section 106 by section 4(f)(9) or 4(h) of the BHC Act.14
In 2003, the Federal Reserve proposed a significant interpretation and proposed supervisory guidance of the anti-tying restrictions ("Proposed 2003 Interpretation").15 The Proposed 2003 Interpretation would have codified many Federal Reserve interpretations and private rulings. However, it was never finalized – if it had been, it would reenforced the Federal Reserve's view that deposits are a traditional bank product, and that banks may tie the availability or pricing of a credit product to the requirement that a borrower place some, or all, of its deposits with the bank. The Proposed 2003 Interpretation was the last time the Federal Reserve officially addressed anti-tying.
SVB required borrowers to keep some or all of their deposits with SVB – in retrospect, this was a bad practice by all
As discussed above, this was standard practice at SVB and appears to have been mostly legal under applicable legal and regulatory requirements. This practice also appears to have directly led to the ultimate failure of the bank: while the tying of deposits may not have been the sole cause of the bank failure, the tying of deposits helped accelerate the bank run that ultimately failed the bank. Specifically, contemporaneous news reports indicate that certain venture capital borrowers learned of issues at SVB, began pulling out their deposits all at once, communicated directly or through social media with other significant depositors, who then pulled out their deposits en masse.16 The effect of these individual and coordinate actions was to create the first true high tech bank run.
The deposit tying practice had demonstrably bad effects: (i) it eliminated the ability of borrowers to spread out bank credit risk, (ii) it made no account for depositor diligence of SVB's health (eliminating a prime factor that led to a material moral hazard), (iii) it effectively over-collateralized SVB's loans, which reduced the need for significant risk management by SVB on borrowers, and (iv) it reduced the ability of borrowers to use those deposits in a more productive economic manner.
How could this moral hazard be fixed?
One method to stop bank runs is to increase the coverage of deposit insurance. If a borrower's deposits are mostly or fully insured, there is no incentive for that borrower to withdraw its deposits when it fears its bank is in trouble. There are current bills and hearings in Congress analyzing this issue;17 the FDIC also published a paper discussing this concept.18 One potential solution would be to increase the deposit insurance coverage of transaction accounts (checking accounts), at least for business accounts which would permit businesses to deposit their payrolls without concern over the effect of potential bank failures.
But would this change be enough? Would it have stopped SVB from failing? Probably not, as its depositors were made up of extremely large financial institutions (venture capital and private equity firms) whose deposits were larger than any likely increase of deposit insurance would cover. Further, deposit insurance coverage increases are paid for through assessments of the insured banks. Those banks would likely pass such costs onto all borrowers, spreading a risk caused by a few to the expense of all.
Instead, the Federal Reserve, FDIC and Secretary of the Treasury (in consultation with the President) invoked the systemic risk exception, which had the effect of bailing out the large venture capital and similar depositors who helped start and help feed the bank run that helped fail SVB.19
Potential policy changes to modify this risk
Here are a few potential changes that could help stem the risk of future bank runs:
1. Modify the ability to tie deposits as a traditional bank product
a. The Federal Reserve should place limits on use of this exception. While tying deposits is a traditional bank function, the tying of all deposits in material amounts so that the borrower cannot use other banks should be limited. This has the negative effects that we detailed above. Such change may require Congressional action (as the definition of traditional bank product is statutory language), but it is possible that the Federal Reserve could interpret this language as applying to deposit tying as done at the time of the passage of that provision, and additional percentages or amounts may be modified through regulatory action. The Federal Reserve could also limit the use of deposit tying to insured deposits and eliminate the ability of banks to tie uninsured deposits.
2. Increase liquidity requirements on banks to take account of deposit tying.
a. Current short- and long-term bank liquidity requirements are based on potential outflows of funds over defined periods of time. They do not appear to take account of the collective effect of over-reliance by a bank on a particular depositor or depositors from a specific industry which may act in concert. Liquidity requirements should be modified to take into account the fact that entities in similar industries may discuss issues with common banks and act together in ways that were difficult to accomplish prior to social media.
Conclusion
The role of deposit tying in the failure of SVB has been under analyzed but appears to have been a significant factor. The Federal Reserve should review the ability of banks to require borrowers to hold a material amount of deposits at the same bank and review the effect of tying on bank liquidity and systemic risk.
Iqra Bawany (Associate, New York, White & Case) assisted in the development of this publication.
1 First Republic Bank, a New York chartered State non-member bank, was seized by its regulators and sold to JP Morgan on May 1, 2023. First Republic Bank was slightly larger than SVB in terms of assets. SVB remains the largest bank failure in which the failed bank was not wholly acquired by another entity.
2 Emily Flitter and Rob Copeland, Silicon Valley Bank Fails After Run on Deposits, N.Y.TIMES (March 10, 2023) https://www.nytimes.com/2023/03/10/business/silicon-valley-bank-stock.html
3 Priya Anand, Priscila Azevedo Rocha, Paula Seligson, SVB Clients at Risk of Default May Have No Choice But to Return, BLOOMBERG, March 15, 2023, https://www.bloomberg.com/news/articles/2023-03-15/svb-clients-at-risk-of-default-may-have-no-choice-but-to-return#xj4y7vzkg.
4 Act to Amend the Bank Holding Company Act of 1956, and for Other Purposes, Pub. L. No. 91-607 (1970);
12 C.F.R. § 225 (1984) ("Regulation Y").
5 See Press Release, Joint Statement by Treasury, Federal Reserve and FDIC (March 12, 2023) https://www.federalreserve.gov/newsevents/pressreleases/monetary20230312b.htm
6 Id.
7 Prop. FDIC Rule 12 C.F.R. § 327 Fed. Reg. 32694 (May 22, 2023)
8 Priya Anand, Dawn Lim et al., SVB Bank Failure Exposes Tech Venture Capitalists to Huge Financial Risk, BLOOMBERG NEWS (March 12, 2023) https://www.bloomberg.com/news/articles/2023-03-13/svb-bank-failure-exposes-tech-s-venture-capitalists-to-huge-financial-risk
9 Upstart Holdings, Inc. Amended and Restated Loan and Security Agreement (SEC Exhibit 10.9) https://www.sec.gov/Archives/edgar/data/1647639/000119312520288095/d867925dex109.htm
10 DocuSign Credit Agreement (SEC Exhibit 10.11) https://www.sec.gov/Archives/edgar/data/1261333/000119312518099555/d506878dex1011.htm
11 Edgio Fifth Amendment to Loan and Security Agreement (SEC Exhibit 10.15.04) https://www.sec.gov/Archives/edgar/data/1391127/000139112720000071/llnw-3x31x2020xex101504.htm
12 Dexcom Loan and Security Agreement (SEC Exhibit 10.26) https://www.sec.gov/Archives/edgar/data/1093557/000119312513069590/d449646dex1026.htm; note the requirement to hold securities and investments accounts with SVB was likely a violation of the anti-tying restrictions, as those products are not traditional bank products.
13 Hyperion Therapeutics Loan and Security Agreement (SEC Exhibit 10.24) https://www.sec.gov/Archives/edgar/data/1386858/000119312512245995/d178027dex1024.htm; same analysis as the footnote above with respect to securities accounts.
14 Regulation Y supra n.4.
15 Federal Reserve System Docket No. OP-1158 "Anti-Tying Restrictions of the Bank Holding Company Act Amendments of 1970" https://www.federalreserve.gov/boarddocs/press/bcreg/2003/20030825/attachment.pdf
16 J. Anthony Cookson, Corbin Fox et al., Social Media as a Bank Run Catalyst (Université Paris-Dauphine Research Paper No. 4422754 (April 18, 2023), https://ssrn.com/abstract=4422754; Ben Cohen, The Surprising Risk that Turbocharged a $142 Billion Bank Run, WALL STREET JOURNAL (April 28, 2023) https://www.wsj.com/articles/silicon-valley-bank-run-twitter-59061759
17 Secure Viable Banking Act H.R. 1602 (proposed March 14th 2023) https://www.congress.gov/bill/118th-congress/house-bill/1602/all-info?s=1&r=8; Examining the Failures of Silicon Valley Bank and Signature Bank Hearing Before Senate Comm. On Banking, Housing and Urban Affairs (Tuesday 16, 2023) available at https://www.banking.senate.gov/hearings/examining-the-failures-of-silicon-valley-bank-and-signature-bank ; Zachary Warmbrodt and Victoria Guida, 'Justified anger': Key takeaways from Senate hearing on SVB's collapse, POLITICO (March 28, 2023) https://www.politico.com/news/2023/03/28/senate-silicon-valley-bank-hearing-00089166
18 Federal Deposit Insurance Corporation "Options for Deposit Insurance Reform" (May 1, 2023) https://www.fdic.gov/analysis/options-deposit-insurance-reforms/report/options-deposit-insurance-reform-full.pdf
19 There is significant discussion about which persons or entities were most helped by the invocation of the systemic risk exception. See (5) Banks Argue Over Who Really Benefited From the Protection of Uninsured Depositors (substack.com)
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