On March 2, a few friends from the banking sector invited me to lunch. As soon as we sat down, the bank manager excitedly showed me a flashy message on her phone: “Look, our latest USD deposit product offers a 5% interest rate. Hurry and transfer your dollars over here.”

A 5% deposit interest rate—who wouldn’t be tempted? However, being tempted does not necessarily mean taking action. For me, moving money around to chase a few extra percentage points doesn’t seem worth the time value I would expend. It’s not that my hourly rate is high; it’s that my balance is too small.

Mark Mobius, known as the “Emerging Markets Guru,” is different. When he needs to move money, any delay prompts complaints. According to reports, this investment titan publicly grumbled about difficulties transferring funds from his HSBC Shanghai account abroad. Given his balance, the daily interest alone is likely substantial.

On March 7, Mobius responded to the media: “It seems the issue has been resolved.”[1] How was it resolved? More on that later.

On March 9, the renowned Silicon Valley Bank (SVB) experienced a bank run, with customers seeking to withdraw a total of $42 billion that day. SVB lacked sufficient funds to meet the demand. A textbook “bank run” unfolded. The following day, the U.S. regulatory agency FDIC took over the bank. Thus, SVB became the largest U.S. bank to fail since the 2008 financial crisis and the second largest in U.S. history, behind only Washington Mutual Inc., which collapsed in 2008.

On March 11 and 12, many companies unable to pay salaries due to frozen funds used the weekend to catch their breath while urgently raising capital. Panic spread through the market, with speculation rife about which financial institution would be the next to fall.

I. Good Customers, Fast Moves

By the end of 2022, SVB had over $200 billion in consolidated assets and $175 billion in deposits[2]. How did a bank with a 40-year history and an illustrious reputation, having weathered the dot-com bubble and the financial crisis, collapse in the spring of 2023?

SVB was renowned for serving innovative companies. Its depositors were typically institutional investors-backed startups, not ordinary individuals. Even individual clients were mainly high-net-worth individuals or highly educated professionals with access to information and strong execution capabilities.

Regarding the Federal Reserve’s eight interest rate hikes within a year, SVB’s clients were more akin to Mobius’s urgency, being institutions with high balances, informed, and efficient. In contrast, many retail clients at other commercial banks of similar size would behave more like my laid-back approach—perhaps unaware of the value changes brought by rate hikes, or even if aware, lacking the energy to act immediately.

In truth, the primary reason SVB’s clients moved funds was not merely to chase better deposit rates at other banks, but because they were at the forefront, feeling the changing tides. In November of the previous year, the crypto exchange FTX had collapsed, and shortly before, another small California bank serving tech companies (SilverGate Capital) had entered bankruptcy proceedings. The entire tech industry felt the pressure of funding shortages. The bank’s risks were already evident.

Unlike the 2008 financial crisis caused by subprime mortgage risks, SVB did not engage in high-risk investments. In recent years, the Fed injected trillions of dollars in liquidity to stimulate the economy, benefiting venture capital firms and startups. These easily obtained funds became high-quality deposits for SVB, which grew fourfold in five years. Even so, SVB did not lose its head, primarily investing in very safe bond products.

Over the past year, the macro environment changed dramatically, with the Fed’s interest rate surging from zero to 4.5%. Such rapid and significant rate hikes immediately produced two direct consequences.

First, higher capital costs made it increasingly difficult for startups to secure financing. The scale built on easily obtained funds required more follow-up capital, and without new investments to fill the gap, companies had to burn through their deposits.

Second, as interest rates rose, the prices of fixed-rate bonds fell correspondingly. (The market mechanism of this basic principle need not be elaborated here; its practical effect is indisputable.) As a publicly traded company, the decline in value of SVB’s bond holdings was visible to all, triggering short selling in the capital markets. These short sales raised concerns among depositors, some of whom began transferring funds. SVB faced liquidity pressure and had to sell bond assets at a loss to raise cash, further exacerbating depositors’ pessimism. Thus, the bank run on March 9 unfolded quickly. The speed of SVB’s collapse was closely tied to its concentrated client base of venture capital firms and their portfolio companies. Ordinary retail depositors, whose deposits are generally covered by the FDIC’s $250,000 insurance limit, do not worry about bank failures and are unlikely to analyze news of bond sales.

No bank can withstand all its depositors demanding withdrawals on the same day. The fundamental “short-term deposits, long-term loans” business model of commercial banks relies on a time gap. Mismanagement of that gap leads to a bank run. In 1983—the same year SVB was founded—the young economists Douglas W. Diamond and Philip H. Dybvig created a concise economic model of this phenomenon using mathematical language. This academic achievement, together with former Fed Chairman Ben Bernanke, earned them the 2022 Nobel Prize in Economics.

From many perspectives, SVB was a healthy bank. However, its book health was not enough to alter depositors’ psychology and behavior. Ironically, the very factors that contributed to its health later accelerated the bank run—a case of fortune turning into misfortune.

II. “Sand in the Wheels”

According to the South China Morning Post, Mobius described his experience at HSBC Shanghai as follows: “They don’t say I can’t transfer the money out. But they say, ‘Please provide 20 years of records showing how you earned this money. It’s crazy.’”

In truth, it’s not HSBC that is crazy; the media enjoys spreading such alarmist tales. Both Chinese and foreign banks have anti-money laundering compliance obligations. Even for domestic RMB deposits moving between accounts, banks have reasons to inquire about the legal source of funds. In the U.S., a wealth manager may gladly open an account for you, but the bank’s compliance officer will still call or send letters demanding explanations of the legal source of funds. Domestic U.S. transfers are frequently suspended for anti-money laundering investigations; delays of days or even months with legal counsel involvement are not uncommon.

The real issue lies elsewhere. Mobius’s complaints gained widespread attention and even became distorted in Chinese and foreign media because everyone knows that the U.S. rate hikes increase pressure on China’s capital outflows. News that foreign investors’ returns on investments in China cannot be smoothly repatriated fits this market psychological expectation. Of course, such expectations can be further amplified by such reports, leading to actual changes—a “self-fulfilling prophecy.”

In foreign exchange matters, risks similar to the bank run SVB experienced are always present. Portfolio capital investors like Mobius and Soros want capital to flow in and out without hindrance to arbitrage globally, which is precisely one factor contributing to financial instability in many countries. As early as 1972—the year after the U.S. unilaterally delinked the dollar from gold, ending the Bretton Woods system—Nobel laureate James Tobin proposed a financial transaction tax to limit rapid capital flows. This concept later became widely known as the “Tobin tax,” which, in Tobin’s vivid words, acts as “sand in the wheels” to slow down transactions. The Tobin tax is not an eccentric idea. In 2015, then-Director of the State Administration of Foreign Exchange, Dr. Yi Gang, published an article suggesting studying the Tobin tax. In 2016, U.S. presidential candidate Hillary Clinton also proposed similar measures to curb high-frequency financial transactions.

Slowing down has its rationale. When Chinese banks handle large foreign exchange transactions, some delays arise from legally mandated compliance measures, while others involve tacit, unspoken delays—such as requiring appointments, or excuses like “the leader is not in today” or “the system is being upgraded; come back another day.” For those involved, these are certainly frustrating, but for the stability of the foreign exchange system, these measures are essentially strategies to put sand in the wheels.

III. Behavioral Strategies in Financial Regulation

Without considering human nature and behavioral characteristics, any legal provisions or risk prevention mechanisms like Basel III can become a Maginot Line. Singapore, with its blend of British legal tradition and Chinese cultural wisdom, understands this well. Recently, the Second Minister for Home Affairs of Singapore responded to parliamentary queries demanding that the government disclose specific criteria for evaluating citizenship applications:

“If we disclose the specific evaluation criteria, some people would exploit them, making it harder for us to maintain the fairness of the citizenship process… Most applicants come from neighboring countries. We do this in full consideration of our country’s unique historical and geographical factors.”

The rule of law is based on the principle of transparency, but exceptions are necessary in specific circumstances. In the U.S., CFIUS (Committee on Foreign Investment in the United States) does not disclose its review mechanisms. For Singapore, due to its small population, limited land area, and unique historical and geographical background, the evaluation rules for citizenship naturalization are not made public. These are behavioral strategies.

For China, foreign exchange is a matter of national financial security. This understanding was embedded in regulatory practice long before the U.S. began focusing on systemic stability after the 2008 financial crisis. Over 45 years of reform and opening up, China has avoided major financial turmoil from U.S. financial crises, quantitative easing, and rate hikes, thanks in part to foreign exchange regulation.

Foreign exchange governance is not just about control and obstruction; the internationalization of the renminbi is a proactive measure to channel capital flows. On March 10, SVB became a victim of the U.S.’s quantitative easing and rate hike “yo-yo” governance model. Coincidentally, on the same day, China successfully facilitated the restoration of diplomatic relations between Saudi Arabia and Iran, making a direct contribution to peace in the Middle East. The U.S. holds vast military, political, cultural, and diplomatic “assets” in the Middle East with impressive book values. However, given the current geopolitical and new energy landscape, China seized the window when the actual value of these massive historical assets was rapidly shrinking, leveraging a small force to achieve a large effect—while promoting regional peace, also laying another cornerstone for the infrastructure of renminbi internationalization.

Diplomacy demands such agility, and financial regulation needs to promptly address problems or seize opportunities amid changing circumstances. Although SVB’s decline from health to failure was rapid, it was not a situation that regulators could not proactively manage. However, U.S. financial regulation suffers from excessive rigidity, and the Fed lacks “clairvoyance” and “all-hearing ears” in macro and micro monitoring—technical or behavioral tools. Its oversight failure regarding SVB was predictable. The federal government’s inaction before the event, followed by using taxpayer money to guarantee all deposits afterward, was a double mistake.

China’s newly formed National Financial Regulatory Administration breaks away from some previous industry divisions, placing greater emphasis on functional regulation, behavioral regulation, penetrating regulation, and full coverage, avoiding passive and futile adherence to the Maginot Line of laws and regulations due to rigid industry segmentation. SVB’s rigid decision-making allowed an originally sound investment to become a risk hazard after rate hikes, ultimately being undermined by the swift actions of its own client base. As the National Financial Regulatory Administration embarks on its journey, the collapse of SVB provides a vivid case study for analyzing behavioral regulation.

Notes:

[1] https://www.yicai.com/news/101694242.html
[2] https://www.fdic.gov/news/press-releases/2023/pr23016.html