00:00:05
Itay Goldstein: Welcome. Today we
are going to talk about the Future of Banking. I am Itay
Goldstein, Professor of Finance
00:00:12
here at Wharton, and the Chair
of the Finance Department. And I am very honored to have two
distinguished guests to help us
00:00:22
dive into this conversation,
into this important topic. I have Hyun Song Shin, who is an
economic advisor and the Head of
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Research in the Bank for
International Settlements. Hello, Hyun. Hello, Itay. Good to join you.
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Great to see you. And Loretta Mester, who
just stepped down from being the President and CEO of the Federal
Reserve Bank of Cleveland.
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Hello, Loretta. Hi. Great to be with you, Itay. So in March of 2023, we had an
unusual string of events in the
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global banking arena. Failures
of institutions here in the United States— Silicon Valley
Bank, Signature Bank of New York
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and First Republic Bank. And of
course, the turmoil in Credit Suisse over in Europe. This was
the biggest episode altogether
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since the global financial
crisis of 2008, and it had a ripple effect on financial
markets worldwide, financial
00:01:32
institutions and the global
economy, with quick intervention from regulators in Europe and in
the United States. Looking now at
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the future of banking, I think
we are looking into a new era with some new lessons that have
been learned and some new
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policies that will be in place.
And I'm here with Hyun and Loretta to dive into these
topics and learn some more and
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talk about what we can expect
going forward. So let me get started by thinking about what
happened in March of 2023. What
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were the causes of these events?
Is there any common unifying theme? Is there any connection
to the policies that were in
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place in the aftermath of the
2008 financial crisis? So Hyun, why don't you get started?
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Yeah. Itay, I think those are
very good questions, and I think we can certainly learn lessons
from what happened in the spring
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of 2023. In some ways, you know,
there are some classical lessons, you know, from the
events, both in the US and also
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in Europe. But in a very
important— in a very important respect, the backing stress
last spring was very unlike what
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we saw during the GFC. I mean,
as you well know, the GFC was a major systemic banking crisis
when many, many very leveraged
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institutions were under stress
on the funding side. And the theme was very much on the— on
the wholesale funding. You know,
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of these large banks. And you may
recall all the discussions about shadow banking and all the
special purpose vehicles and so
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on. But in the— in the stress in
the US, it was much more to do with the classical theme of— of
depository rights that actually
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you have really contributed a
lot on. I think it's important to bear in mind the macro backdrop.
You know, we had this burst of
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inflation in 2021, and so central
banks raised rates in '22 and what that meant was that some of
the securities holdings of
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banks, you know, lost value in a
mark-to-market sense. But you know, many of these securities
were held on a— on a— on a
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UTMA maturity basis, which
meant that the losses needn't be recognized, you know, as they as
they lose value. But in this
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case, in the case of SVB, for
example, there was a— already a very large increase in deposits,
which were then, you know, put
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into these securities. But when
you have a run, you do need to sell the assets, and that's when
the— you know— losses would be
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realized. So I think that was a
very particular feature of the macro environment at that
time. But it wasn't a systemic
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crisis, and those— you know in
the same way that the 2008 global financial crisis was. The
story with Credit Suisse
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was actually somewhat different
still, because, you know, this was a major, globally systemic
banking institution. It
00:05:13
wasn't a retail institution in
the same way that some of the smaller banks were in the US.
But what it saw was, you know,
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after a series of mishaps in
its— you know, in its— in its business, the stresses
that were happening at that time
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meant that its wholesale
creditors were actually, you know, similarly withdrawing,
you know, their funding. And so
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it was a slightly different
episode, but it shares the same kinds of commonalities in the
sense that it was a liability-
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side driven event that
interacted with the asset site. I think that would be one way of
putting it.
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Thank you. And Loretta, some
reflections from you. Yeah. Yeah. I mean,
fundamentally, I think there
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were two key factors for SVB,
Silicon Valley. And they were just doing very poor interest
rate risk management. The Bank
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had, as Hyun said, you know— the
bank had tripled in size in a very short period of time in
terms of its assets. And it was
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funding those securities with a
very high proportion of uninsured deposits. Over 90% of
their funding, short term
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funding, was uninsured deposits.
So they were very vulnerable. And they weren't really managing
that risk. In fact, they kind of
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leaned into that risk because
they— they moved securities into the held-to-maturity buckets on
their balance sheet, so they
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wouldn't have to mark them to
market. And then they were also vulnerable in another way, in
the sense that they had a very
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concentrated depositor base. So
a majority of their deposits came from firms that were in
tech and venture capital. And of
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course, when venture capitals
got under— you know, started— their activities started
declining as interest rates
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increased— they found themselves
in trouble. And they really weren't managing that risk at
all. But the second factor— and
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you know, we know banks are
basically, you know, set up to sort of lend long and borrow
short. And so they're— they are
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subject to interest rate risk,
and it's up to them to manage the risk. But we also have bank
supervision. And supervisors are
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supposed to, you know, make sure
that banks are managing their risk in a safe and sound manner
so that they can continue to
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lend and, you know, serve their
important roles that they do for their customers. And in this
case, bank supervision also was
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very weak. The supervisors
didn't— and the Fed was responsible for much of this.
The Fed— we didn't really
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understand the vulnerabilities
of SVB, and especially as the institution grew in size. And
once the vulnerabilities were
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fully appreciated, then the
supervisors didn't act quickly enough and forcefully enough to
get SVB management to fix the
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problems they were having. So I
would say it would be a combination of both poor
interest rate management, risk
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management on parts of SVB— and
of course, they're the the chief ones who were supposed to manage
that risk. And then also
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combined with weak bank
supervision that, you know, really wasn't done with speed
and agility in a changing
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interest rate environment. So Hyun
was right. When interest rates began rising, and they rose
aggressively, it really revealed
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the vulnerabilities in that
bank. And then what happened was, of course, once depositors
sort of woke up and said, "Oh,
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we're— we have some concerns
here." And they were alerted to this fact because SVB tried to
do a capital raise and had to
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sell assets to do so, so they
had to take those losses. Then depositors started to run, and
that— while it wasn't a systemic
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event at the moment, it did
cause runs at other banks, like First Republic and Signature
Bank. And there was concern that
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it would become a systemic
event. And many large regional banks suffered in terms of
depositors running. And, you
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know, this may be indicative of,
we have not solved "too big to fail." The deposits ran into very
large banks because the
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depositors believe that those
banks would not be allowed to fail. So we have not solved that
problem. Coming out of the— the,
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you know, financial crisis,
there were a lot of reforms done. Dodd-Frank, you know, part
of that was to try to address
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the "too big to fail" problem. And
I think this episode shows that that has not been adequately
addressed. So— so I agree with
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Hyun. There's— there are lessons
here, certainly, that the regulators and the Federal
Reserve are taking to heart in
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terms of how we do supervision
and also regulatory changes. But here, I'd put more of the
burden on the supervisory part
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of it, not the regulations
themselves. So let me follow up on this. You
both mentioned the connection to
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monetary policy. And Loretta, you
said that there are lessons now going forward for supervision
and regulation. But another
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question is, what are the
lessons going forward for the way that the Fed is conducting
monetary policy? To the extent
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that you can say something about
that? Well, remember, this all
happened in early March, and
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there was an FOMC meeting on
March 22 of that year. To— March, 22, 2023. And at that
meeting, the Fed persevered and—
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in its interest rate increase.
So it did another increase of 25 basis points. So we didn't allow
the stresses in the banking
00:10:56
system, per se, to deter from
what needed to be done from a monetary policy point of view,
given where inflation was.
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Because inflation at the time
was running above 5% and it was clearly well above the goal of
2% and unemployment was very low
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at the time. So of course, the
obvious thing to do with your monetary policy is to tighten
interest rates again. And we did
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not let those stresses— however,
you know, there was certainly a lot of focus on whether those
stresses would become wider
00:11:33
spread. And there was concern,
if you recall, when SVB failed, the Fed also set— had to set up
an emergency lending facility,
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the bank term funding program,
and that allowed banks to— that were having liquidity issues— to
put these securities that they
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were holding on their balance
sheet at face value, they could actually put them at the Fed at
fair value and borrow against
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them so they wouldn't have to
sell them. That program, combined with what the Treasury
and FDIC did for some of the
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banks, which basically said,
we're going to make sure that all deposits are insured, that
kind of quelled the stresses. So,
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you know, the FMC felt, you
know, that there was risk out there of continuing on its
campaign of raising interest
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rates, but it was the right
thing to do from a monetary policy point of view. And then
we'd have to very, very— be
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attuned to those risks, because
if they did— you know, you need to have a healthy banking system
for two reasons. One, you want
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monetary policy, whatever
action you take on the policy front, to actually transmit
through the broader economy.
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When the financial markets
aren't working, when they're disruptive, monetary policy
won't transmit. But also, we
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wanted the banks to remain
healthy and not pull back on all the credit extension, because
they were actually support—
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helping to support the economy
as well. So there was a lot of discussion about— and, you know,
we've got to continue monitoring
00:13:05
this. But we were able to
persevere and and put another interest rate increase in. And
that's thanks to—
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really likes to use, you know,
regulation, supervision, macro credential, to the extent we
have it in the US. Tools to focus
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on financial stability. And then
have its monetary policy tools, interest rate increases or asset
purchases and balance sheet
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policies, really focused on the
macro policy goals of full employment and price stability.
And so we were able to do that,
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but there was a lot of attention
paid to, we are taking some risk here. And you'd have to sort of
make an evaluation of whether
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you thought we could continue on
that. And we were looking at that. I think the broader
question, Itay, and maybe this is
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one that you were alluding to,
was— you know, we— we were raising interest rates very
quickly. You know, unprecedented
00:14:07
quickness in how we were
having to raise interest rates. We had to do that, given where
inflation was. But no one felt
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that, you know, we, we— that— we
would have preferred not to have to do that. Let's put it that
way. But monetary policy was so
00:14:23
out of position for where it
needed to be, given what was going on in the macro economy,
that we we had to do that. So I
00:14:30
think one of the lessons is, is
don't let your monetary policy get out of position. Always
maintain it being in a good
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position, which means always
being attuned to the risk. Upside risk, downside risk,
inflation risk, unemployment
00:14:45
risk, so that you aren't in a
position where you feel you have to really move quickly and at
large increases or decreases,
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which can be hard for financial
markets and institutions to handle. Yeah, that's a that's a very
important lesson. So Hyun,
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turning back to you, you sit in
the Bank for International Settlements, and you think a lot
about international coordination
00:15:10
of financial regulation and
supervision, what happens with cross border transactions and
international banks. And you
00:15:21
know, to some extent what
happened in March of 2023, a lot of it was concentrated in the
US, but then we saw how the
00:15:29
panic and sentiment kind of
spread over and affected Credit Suisse in Switzerland. Even
though the fundamentals there,
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the situation there, was very
different. So what do you think are the lessons going forward
for coordination at the
00:15:46
international level? Well, Itay, I think, of course, you
know, regulation is— is going to
00:15:52
be a— you know, very important,
you know, building block in— in any kind of financial stability
framework. But let me just
00:16:00
underline one thing that Loretta
said, which I think is very, very important, which is that—
as well as the regulation, which
00:16:09
is clearly, you know, very
important. And that is something that is discussed at the
International forums like the—
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like the Basel Committee for
Banking Supervision. Supervision itself is going to be really the
key, actually. And I think what
00:16:24
the events of last year showed
was how important it is to get the basics of supervision right.
So the way— the way you should
00:16:34
think about the difference
between regulation and supervision is, you know,
regulation are the hard rules.
00:16:40
You know, the ratios,
particular numbers, capital and liquidity and so on. But the
supervision really has to do
00:16:49
with, you know, the business
model. How coherent is it? How good is the risk management? And
as Loretta explained very well,
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you know, it was those business
model issues, the risk management issues, which really
came to the fore. And so before
00:17:05
we even go to regulation, I
think we have to emphasize how important supervision is. And
that's really done at the
00:17:12
national level. So it's the
national supervisors who are, you know, in the driving seat.
Now, with the regulation, what—
00:17:20
what will be important for the
international, you know, forums like the Basel Committee, would
be when competition also becomes
00:17:30
part of the— part of the
discussion. So one of the— you know, if you— if you go back to
the very first Basel Capital
00:17:39
Accord, back in 1988, you know
that that accord came about because of this— because of the
consensus, I think, among all
00:17:50
the supervisors, that there
needed to be a way to make sure that the internationally
active banks who compete in
00:17:58
various, you know, markets
globally, are competing on a level playing field. So, you
know, no one jurisdiction is—
00:18:08
you know, that is deviating very
much from others, in that, you know, one— in that that
jurisdiction, its bank somehow
00:18:15
has an advantage, you know,
competitively. And so it's a way to prevent this race to the
bottom, or potential race to the
00:18:24
bottom, where, if the
competition is unfair, then some banks may be at a greater
advantage relative to other
00:18:35
banks. And so that's really the
role of the international coordination. And this is what
the Basel Committee is— you
00:18:46
know, has been a very, very
important piece in this— in this international discussion. But
it's very important to emphasize
00:18:56
that the— you know, it is the
national supervisors who are in the driving seat. And whatever is
discussed in the Basel Committee
00:19:04
doesn't have the same kind of
legal force as, you know, something like an international
treaty. I mean, it's very much a
00:19:12
discussion shop. And whatever is
discussed is then implemented by the national— you know, by the
national authorities. So I think—
00:19:22
so to that extent, the lessons
that I think we learned in March of last year, they're being
actively discussed in ways—
00:19:34
through various, if you like,
strengthening at the national level of the national
regulation. So liquidity,
00:19:42
clearly, is a very important
part of this. And, you know, this is still, you know, very
much in process at the moment.
00:19:51
But I think it's— I would say
that the— that the role of international discussions has to
be sort of, you know, put in
00:20:00
this broader context. So there
is a fairly limited role there in terms of coming up with
specific recommendations. But
00:20:08
it's very much a part of the
consensus building among the national supervisors.
00:20:15
- Okay. And a different aspect of
government intervention, government involvement, I would
say, is deposit insurance. For
00:20:25
many years, this was a very
important part of addressing financial fragility and
preventing crisis. We saw that
00:20:35
deposit insurance was updated in
the US in 2008 following the beginning of the global
financial crisis. Since then, it
00:20:43
hasn't been updated. But then in
March of 2023, after the run on SVB and the beginning of runs in
other banks, there was this
00:20:54
shift to kind of implying that
everyone will be guaranteed, whether they are insured or not.
And now there are discussions.
00:21:03
Maybe the policy should be
updated. Maybe there shouldn't be a limit. Maybe there should
be some distinction on what is
00:21:09
the limit on different kinds of
deposit, different kind of accounts. So where do you think
this is going, deposit insurance?
00:21:17
And I think either one of you
could take this question. Well, Itay, you're right. There
are a lot of proposals out
00:21:25
there. I mean, whenever I—
whenever I think about these things, I always think about
you, you want to sort of have
00:21:31
market discipline working with
bank supervision and bank regulatory rules, including
deposit insurance. So I'm not
00:21:39
sure the first place I would go
would necessarily be to just have a blanket increase in the
cap on deposit insurance,
00:21:49
which is at 250,000 per
depositor at this point. But there are things that are
probably worth considering. I
00:21:56
mean, and one thing is, is
well— that's smaller now than when it was set in 2008.
Because, of course, the economy
00:22:03
has gotten bigger. So there are
people who think that, well, you could just adjust— you should
adjust that just on that
00:22:08
ground. But I also think you
want to think a little more thoughtfully about, one, what
would be the trade off there?
00:22:18
Because someone has to pay for
that higher level of a deposit insurance. Right now, the banks
pay fees. But if they're paying
00:22:26
that, and they're covering that,
then of course, they wouldn't be able to lend as much. So you
have to think about whether
00:22:32
that's the right approach. I
think one thing that became clear in this SVB situation was
that, you know, a lot of their
00:22:41
customers and firms, and even of
other regional banks, were really concerned that they wouldn't be
able to pay their customers, you
00:22:48
know, pay their workers. You
know, payroll. They were doing payroll services. And so there
is an idea that you could
00:22:55
distinguish business accounts,
transactions accounts, from other kinds of deposits and have
a special account and special,
00:23:05
you know, deposit insurance for
those, because those are really important for the functioning of
the economy. But the whole idea
00:23:12
of these is to try to make sure
that depositors don't feel that they're in a situation that they
have to run to be the first to
00:23:18
take their money out of the
bank. The other approach, aside from deposit insurance, which I
think for the US in particular,
00:23:25
is— and there's work going on—
is, you know, we have a discount window. And the discount window
is the Federal Reserve, as a
00:23:33
central bank, lends to healthy
firms when they have temporary liquidity problems, as long as
it's backed with, you know, good
00:23:43
collateral. In the case of— of
this, of the stresses in March, you know, it became very clear
that the regional banks— not the
00:23:51
ones that were on the way to
failure, but the ones that were finding that it was hard to fund
in the— in the environment that
00:23:57
we were in with the stress— were
very reluctant to come to the discount window. They didn't—
they didn't really feel that
00:24:04
they could, without stigmatizing
themselves. And I— in other countries, their lending is not
as stigmatized. At some
00:24:13
countries, it's not at all,
compared to the US. So there's work going on at the Federal
Reserve to try to make the
00:24:20
discount window much more
attractive in terms of making sure that banks know and are
well positioned to be able to
00:24:28
use the discount window. So for
example, you know, the legal documents that— agreements that
have to be in place— there's a
00:24:35
big campaign to make sure that
firms, the banks and institutions that are eligible
to borrow at the discount window,
00:24:43
have those already in place.
That they have collateral already evaluated, so that they
can borrow much more quickly
00:24:51
than was the case during the
stresses of March 2023. So— and that has been very worthwhile. I
think, the number of
00:25:00
institutions now— I think that
if you think— if you think about banks, as well as credit unions,
who are eligible to borrow, it's
00:25:07
probably around 8000
institutions. And I think it's well over 5000 that have those legal
documents in place now. So
00:25:13
there's been work to try to do
that. But ultimately, it's still a bit stigmatized. Even if— even
if banks are able to borrow,
00:25:22
will they borrow? And so there's
work going on to try to maybe give a carrot as well as a
stick. So for example, include
00:25:32
discount window contingent
funding as part of the liquidity plans that banks have to submit
as part of their showing that
00:25:42
they're doing safe and sound
liquidity management. Or, you know, making sure that borrowing
from the discount window
00:25:50
doesn't count against the bank
in terms of their supervisory treatment. So there's work going
on to try to destigmatize the
00:26:01
discount window and make it part
of the plan for contingent funding that— that institutions
have. And I think that's very
00:26:09
promising, and that may be as
promising as any kind of reform of the deposit insurance.
00:26:16
Hyun, did you want to add to
that? Yeah. Let— let me add, Itay,
that, you know, as— as Loretta
00:26:22
laid out very well, I think we
have to think about the deposit insurance discussion within the
broader context of liquidity
00:26:30
risk for the bank, and how you
would manage that liquidity risk. So you know, simply
focusing on deposits would not
00:26:40
address, for example, some of
the issues that banks faced during the GFC. You know, when
the problem was the wholesale
00:26:48
funding market. And the run, if
you like, on some of those banks were happening because some of
the wholesale creditors were
00:26:56
shrinking their exposure, you
know, for their own risk management reasons. And so it's—
you know, it's more prudent
00:27:03
behavior. It's more prudent
lending on the parts of the— of the party that's shrinking that
funding, but it looks like a
00:27:10
run, if you're, you know, on the
receiving end. So it has to be— so the discussion about— about
about deposit insurance should
00:27:18
be placed in this broader
context of funding risk, you know, for the— for the bank. And
as Loretta laid out very well,
00:27:28
the— a crucial part of that is
the role of a central bank as the lender of last resort. And
what it would take for the
00:27:40
collateral framework, or the—
you know, the criteria and the rule book for the emergency, you
know, funding from the central
00:27:52
bank to be done without— you
know, without the kind of, you know, the— the stigma issues that
Loretta mentioned.
00:28:03
Okay, so we're coming very close
to the end here. I want to finish by thinking about the
future of the banking system,
00:28:14
and maybe give each one of you a
minute to reflect on, are we going towards a different kind
of financial system, a different
00:28:23
kind of banking system? You
know, one thing that we see is more consolidation. As Loretta
mentioned before, there was a
00:28:31
run from the small banks to the
large banks. So maybe we will have fewer and fewer smaller
banks going forward. Something
00:28:39
else, of course that comes to
mind is the digitization and the fact that digital deposits are
much easier to withdraw, and
00:28:49
maybe the liquidity that banks
have is no longer adequate to deal with that. So where are we
going in terms of the future of
00:28:57
the banking system? I know this
is very broad, but this is a concluding question. And please,
each one of you just take a
00:29:04
minute or so to reflect on that. Yeah, Itay, maybe I can just kick off with a
very, you know, quick point
00:29:12
about the distinctive, you know,
nature of banks. I mean, banks are distinctive in that
deposits are the main means of
00:29:21
payment. So, you know, we— we
execute payments by, you know, debiting the account of the
sender and crediting the account
00:29:33
of the receiver, and it settles
through the central bank's balance sheet. So in that
respect, you know, banks are not
00:29:39
only, you know, bringing in
funding and lending, they're also essential for the— for the
monetary system to work. And
00:29:47
what we've been doing, actually,
at the BIS, is to— to use some of the technological innovations. In
particular, we have a project
00:29:54
called Agora, which is about
revamping correspondent banking by using tokenization.
00:30:03
And tokenization is
this idea that you can have claims in transfer
on a programmable platform.
00:30:10
And so you can really build in
contingencies and— and other features. And— and I think if we
look to the future,
00:30:19
my sense is that we will be
speaking more and more about the role of banks as the
pillars of the monetary system,
00:30:26
you know, as well as
intermediaries that lend. Loretta? Yeah. I— I don't disagree with that.
I mean, but
00:30:34
I'd also point out that everyone—
you know, we— we have these problems every— periodically.
They come up
00:30:40
in the industry, and there's
always people who say it's the end of the industry,
and everything's going to become
00:30:45
non-bank. Well, the banking
industry's been around forever. And I think it will change,
and I think the regulatory
00:30:53
supervisory structure will
have to change, in order to make sure that we have financial
stability, which is crucial
00:31:01
for a healthy economy. And,
you know, the distribution of the size of banks is likely
to change, because, you know,
00:31:08
technological changes, and—
you know, some of my own research shows that the—
you know, an efficient
00:31:14
size of a bank is much larger
now than it used to be. But it mean that community
banks won't
00:31:21
stay, and still do what they
do best, which is lend to their local community.
So I think
00:31:27
it will change over time. What I'm hoping is in the US,
we get a little bit of a
00:31:32
simpler structure. Because
it's very different from in a lot of other countries. But
I think the role,
00:31:38
the important role that banks
have— and as Hyun points out,
they're— they're becoming
00:31:44
more and more important
in terms of the payment system. And of course, the Fed launched
its instant payment system,
00:31:53
you know, over a year
ago, and it it's being built up now, in
terms of more and more
00:31:58
firms becoming customers
of FedNow. I think that's sort of where
things are going,
00:32:04
and technology can be very
helpful to more efficient, more safe,
more sound banking.
00:32:14
But it also shows, in the
speed of the runs that occur, it also can lead to
more challenges.
00:32:21
So I think we are in a very
exciting time of change. But fundamentally, if you
think back to the stresses
00:32:28
of March 2023, it wasn't a big esoteric thing
that went on. It was just basic poor risk
management,
00:32:38
and weak supervision.
And I think those are things that we all have to
take to heart,
00:32:44
whichever side you're on. If
you're a bank, banker, or a regulator-slash-supervisor,
00:32:51
in that we can do the basics
better than we showed that we were doing in March
2023.
00:32:57
Okay. A lot to think about. Thank you very much, Loretta
and Hyun, for a very stimulating discussion.
00:33:06
And thank you for everyone
who was listening. Thank you, Itay. Thank you very much.
- Thank you.