The not-so-hidden risks of ‘hidden-to-maturity’ accounting

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How can understanding 'hidden-to-maturity' accounting practices help prevent future bank collapses like the SVB meltdown in March 2023? This author presents a model analyzing balance sheet vulnerabilities and depositor run risks, providing insights into bank resilience and regulatory strategies.

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Institution: Stevens Institute of Technology

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How can understanding ‘hidden-to-maturity’ accounting practices help prevent future bank collapses like the SVB meltdown in March 2023? This author presents a model analyzing balance sheet vulnerabilities and depositor run risks, providing insights into bank resilience and regulatory strategies.

Image courtesy of interviewee. November 20, 2024

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This video discusses a mathematical modeling project initiated in response to the collapse of Silicon Valley Bank (SVB) in March 2023. The authors analyze the bank's high percentage of uninsured deposits and the implications for bank runs, referring to classic models of banking behavior. They highlight that 90% of SVB's deposits exceeded the FDIC insurance limit, which contributed to a panic run on the bank, exacerbated by rapid information dissemination via social media.

Additionally, the text delves into the concept of "held to maturity" (HTM) assets, which are meant to be kept until maturity without needing to adjust their value based on market fluctuations. The authors emphasize the significance of properly managing these positions in light of the rising interest rates at the time, and the risks associated with having a large amount of these assets.

The model developed by the authors aims to evaluate the risk of bank runs by examining factors such as the percentage of uninsured deposits and the quality of the bank's assets. They found that SVB was managing its risk prudently until late 2022 but failed to adjust its HTM asset positions in time to mitigate risks associated with a changing economic environment.

The analysis extends beyond SVB to include other banks like PNC and First Republic Bank, noting that PNC effectively unwound its HTM assets and, as a result, was better positioned to withstand risks. The authors conclude that understanding a bank's accounting practices, especially regarding HTM versus available-for-sale assets, is crucial for assessing its risk level. They suggest that regulatory frameworks should consider a bank's specific context, including the proportion of insured vs. uninsured deposits, to prevent future failures like SVB’s.

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Here are five key points from the video regarding the analysis of Silicon Valley Bank (SVB) and broader banking issues:

1. **Understanding Bank Risks**: The project began in the aftermath of Silicon Valley Bank's failure in March 2023, focusing on analyzing the high percentage of uninsured deposits and the accounting practices that may have contributed to the bank's collapse. The mathematicians aimed to structure their analysis to provide insights into what went wrong, particularly looking at the risks associated with uninsured deposits and the "held to maturity" assets.

2. **The Role of Uninsured Deposits and Bank Runs**: A significant point raised was that SVB had over 90% of its deposits uninsured, which created a vulnerability to bank runs. This situation contributed to panic and withdrawal behaviors exacerbated by social media communication, contrasting historical bank runs that spread through slower word-of-mouth.

3. **Accounting Standards Impact**: The video discusses the implications of accounting standards concerning "held to maturity" (HTM) assets versus "available for sale" assets. While HTM assets allow banks to avoid marking them to market value and thus mitigate short-term risks, this accounting can mask potential financial vulnerabilities, especially if the bank's asset composition is unbalanced.

4. **Risk Assessment Model**: The authors developed a model to assess the risk of bank runs by analyzing the composition of bank assets and the level of uninsured deposits. They noted that the optimization of HTM assets must consider both potential risks and rewards, recommending that banks keep their holdings within prudent levels to ensure stability under stress scenarios, such as rising interest rates.

5. **Regulatory Implications and Solutions**: The analysis suggests that regulatory changes, like ensuring all deposits or regulating the size of uninsured accounts, can mitigate the risk of bank runs. Notably, Massachusetts has laws mandating insurance on all bank deposits, contrasting with California, where SVB operated. This highlights the potential effectiveness of regulatory mechanisms in preventing bank failures.

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Here are some key quotes extracted from the video, focusing on the main ideas presented:

1. **On the impetus to study SVB:**
- "We want to understand how can we contribute to understanding what happened to SVB, what happened to a couple of other kind of mid-sized US banks at that time."

2. **Regarding uninsured deposits:**
- "SVB had very high percentage of uninsured deposits...90 plus percent of their deposits back in March, 2023 were uninsured."

3. **On the concept of bank runs:**
- "If there is no deposit insurance...people will run on the bank just based on fear."

4. **Describing the held-to-maturity (HTM) accounting:**
- "The idea is these are assets that you have...it's supposed to be intent and ability to hold these assets until they mature."

5. **Explaining the risk associated with HTM:**
- "There's also a risk to doing it...so we try to optimize between the risk and reward."

6. **Insights on Silicon Valley Bank's actions:**
- "Up until through 2021 Silicon Valley Bank was acting prudently...but it was not hitting the critical thresholds ultimately at the time of the collapse."

7. **Comparing other banks to SVB:**
- "What we found is PNC prior to the fourth quarter of 2022, unwound its entire held to maturity position...they were, according to our model, in incredibly safe compared to first Republic for Silicon Valley Bank."

8. **On the importance of accounting practices:**
- "How do the banks actually do their accounting? Because ultimately held to maturity versus available for sale is just accounting standards."

9. **Aftermath of the SVB failure:**
- "One key...is to ensure all deposits. If you don't limit the amount of the size of these accounts...you're immediately removing that desire to run on a bank."

10. **On regulatory considerations:**
- "There are jurisdictions within the United States that do actually prevent such a problem...but Silicon Valley Bank...is not subject to Massachusetts law."

These quotes capture the essence of the analysis regarding Silicon Valley Bank’s failure, the dynamics of bank runs, the implications of accounting practices, and regulatory considerations that could help prevent such failures in the future.

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Then we really started this project, this was shortly

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after March, 2023, when SVB

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quite spectacularly, blew up.

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Uh, so we were reading all these reports about,

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the uninsured deposits that were held at SVB, at

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the actual accounting standards they were using about

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how they were hedging their risks or

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otherwise not hedging their risks.

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And we tried to say, we are mathematicians.

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We're coming at this from a

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mathematical modeling standpoint.

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We want to understand how can we contribute

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to understanding what happened to SVB, what happened

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to a couple of other kind

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of mid-sized US banks at that time.

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And also to understand what could be done on other,

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institutions.

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How could we look at other institutions more generally?

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So as we're looking at SVB,

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they had very high percentage of uninsured deposits,

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which kind of the classical bank run models.

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If you go back to Diamond Dip Vig,

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where they won the Nobel Prize in 2022 based on their,

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bank run, study back in the eighties.

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Uh, if we're really looking at that,

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that was saying there's no in, deposit insurance.

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So people will run on the bank just based on fear.

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Uh, then in, subsequent works,

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we really found if there are,

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if there is deposit insurance, then

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we completely eliminate this risk of a bank run

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because ultimately, I will keep my money if it,

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if it's in the bank and the bank

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fails, I still have my money.

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I have no need to run on the bank

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and get my money out first.

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But when we look at SVB, all of a sudden,

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90 plus percent of their deposits back in March, 2023

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were uninsured.

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Were above the $250,000 limit

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that is in the FDIC insurance within the United States.

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So this contributed back to those

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original models on bank runs,

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where now you did have the lines of people trying

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to get their money out

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before SVB collapsed, really in that last week.

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Uh, and this was spread through social media as opposed

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to previously just being word of mouth slower almost.

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Um, but the other big aspect was the HTM,

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the held to maturity or hidden to maturity assets.

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Uh, so officially it is held to maturity, though,

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in the academic literature, people are starting

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to use this hidden to maturity, pejorative.

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The idea being when you have assets on your balance sheet,

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typically in finance, you what's called mark to market.

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Whatever the current outstanding price of that asset is, is

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what you need to say it is worth in your balance sheet,

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held to maturity is different.

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The idea is these are assets that you have.

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The intent and ability according to the rules, it's supposed

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to be intent and ability to hold these assets

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until they mature.

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So if this is government debt,

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it could be 30 year government debt.

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So the idea is you are going

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to hold this asset for 30 years.

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You have no intent to sell it

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before that time is up.

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The reason for this, the reason that we allow these banks

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to do this is it allows 'em to smooth out,

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their cash flows.

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So now as prices fluctuate a little, they're not going

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to have to keep remarking these assets.

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They're not going to have to hedge these risks

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because they say, I don't care about this short term risk.

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I am just worried about this long term, problem.

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There's really two aspects to the model that we developed.

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The first aspect is really looking at

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what is the size of the bank run.

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So you have the balance sheet of these,

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of whatever bank you're looking at Silicon Valley Bank,

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or you can look at a more stable bank like PNC.

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We've done some, subsequent work where we've started

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to look at other institutions,

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and you can basically say, what is the run risk

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that they have based on how much

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of their deposits are uninsured, how much of it, how much

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of their assets are held

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to maturity versus available for sale?

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What are the quality of these assets?

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And we can really use that to say,

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what are the risks of the run?

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What would happen during this event?

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Uh, the second aspect of the model is saying,

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what if we just know the total amount of assets

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that this bank holds?

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So not saying how much of it is available for sale

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or how much of it is held to maturity as the bank are,

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is reporting, but just saying,

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what's the sum total of the assets?

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And then we wanted to figure out, we wanted to study

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what is the, in some sense, optimal amount

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of health maturity that really gets the aspect of the intent

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and ability to hold those assets to maturity.

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So we wanted to look at what kind of stress,

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so the bank has some reasonable stress so that we kind

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of get this idea of the intent and ability.

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So it's a reasonable stress scenario

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that hits the financial market.

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In the case of Silicon Valley Bank,

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that would be the rising interest rate environment

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that was prevailing at the time, to combat the inflation

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that we had in the post covid economy.

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Based on that stress, we want to see that they would not,

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that no bank would have that, this bank would not have to

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Remark its assets, it's held to maturity assets

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and make them available for sale like Silicon Valley

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Bank was forced to do.

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Uh, and other banks, potentially would be forced to do.

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So. Again, there's the advantage to held to maturity,

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but we wanted to say that there's also a risk to doing it.

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Uh, so we try to optimize between the risk and reward.

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When we ran this, this data on Silicon Valley Bank,

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what we found is that up until

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through 2021 Silicon Valley Bank was acting prudently.

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The amount of held to maturity assets

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that they had on their balance sheet was actually

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below the amount that our optimization was saying

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that they could hold.

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Um, in contrast, once we got into 2022

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and early 2023

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before they collapsed,

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the optimization was saying they needed

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to unwind that position.

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It was much too large an amount of health maturity.

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And in contrast, they were not doing that in practice.

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So while they were prudent, there was really,

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we found that there was not this big,

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like you could see the runup of this risk,

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but it was not hitting the critical thresholds

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ultimately at the time of the collapse

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that threshold was being exceeded.

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Uh, so we did find in the case of Silicon Valley Bank

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that there were these big risks, that

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were happening just before their collapse did occur.

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So we've subsequently,

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used the exact same model taking data from other banks.

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Uh, we've been looking at First Republic Bank, PNC,

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Pacific West, and a couple of other institutions,

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and just to try to see do similar,

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effects occur in banks, other banks

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that failed like First Republic

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or banks that did not seem to be at risk like PNC.

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And what we found is PNC prior to the fourth quarter

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of 2022, unwound, its entire held to maturity position.

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So they were entirely unavailable for sale.

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They were, according to our model, in incredibly,

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safe compared to, first Republic

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for Silicon Valley Bank, which had these growing,

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hidden to maturity, positions.

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What this is really telling us when we look at these models,

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when we really try to build these constructions about risk

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is to look at not just, well,

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what's the total asset composition?

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But how do the banks actually do their accounting?

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Uh, because ultimately held to maturity versus available

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for sale is just accounting standards.

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Uh, so the way that this accounting is done

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really should be bank dependent,

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should depend on the different institution, based on

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how much uninsured versus insured deposits they have.

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Because if most of the deposits are insured,

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then there is not the same risk of a run.

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So there is easier to have this ability

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to keep the assets until maturity.

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Uh, in practice, what we found

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and others have reported, the intent

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and ability to hold held to maturity, to maturity, seems

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to be on paper,

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but not in practice in terms of regulatory changes

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that we were kind of investigating.

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One key, one that like jumps out

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that actually was done immediately

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after the failure of Silicon Valley Bank is

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to ensure all deposits.

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If you don't limit the amount of, the size

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of these accounts in, the amount that they'd be able

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to recover, you're immediately removing that desire

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to run on a bank.

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Uh, and actually within the United States, Massachusetts,

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I believe is the only state in the United States

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that actually requires, insurance on all bank deposits,

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not just the FDIC insurance.

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Uh, so there are, jurisdictions within the United States

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that do actually prevent such a, problem.

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But Silicon Valley Bank, famously, primarily in California,

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does not, is not subject to Massachusetts, law.

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Uh, but otherwise it really comes down to,

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and it's hard to judge what intent

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and ability, how you can enforce, those rules.

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But since they are the official rules

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for when you should be doing held to maturity,

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accounting, there should be some way to actually,

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check whether someone can have that intent

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and ability, to follow the rules and regulations.

Analyzing the SVB Collapse: Insights from Mathematical Models

00:00:00 - Then we really started this project, this was shortly after March, 2023, when SVB quite spectacularly, blew up. so we were reading all these reports about, the uninsured deposits that were held at SVB, at the actual accounting standards they were using about how they were hedging their risks or otherwise not hedging their risks. And we tried to say, we are mathematicians. We're coming at this from a

00:00:33 - We want to understand how can we contribute to understanding what happened to SVB, what happened to a couple of other kind of mid-sized US banks at that time. And also to understand what could be done on other, institutions. How could we look at other institutions more generally? So as we're looking at SVB, they had very high percentage of uninsured deposits,

00:01:06 - If you go back to Diamond Dip Vig, where they won the Nobel Prize in 2022 based on their, bank run, study back in the eighties. if we're really looking at that, that was saying there's no in, deposit insurance. So people will run on the bank just based on fear. then in, subsequent works, we really found if there are,

Understanding Bank Runs: The Case of SVB and Uninsured Deposits

00:01:37 - we completely eliminate this risk of a bank run because ultimately, I will keep my money if it, if it's in the bank and the bank fails, I still have my money. I have no need to run on the bank and get my money out first. But when we look at SVB, all of a sudden, 90 plus percent of their deposits back in March, 2023 were uninsured. Were above the $250,000 limit

00:02:10 - So this contributed back to those original models on bank runs, where now you did have the lines of people trying to get their money out before SVB collapsed, really in that last week. and this was spread through social media as opposed to previously just being word of mouth slower almost. but the other big aspect was the HTM,

00:02:43 - so officially it is held to maturity, though, in the academic literature, people are starting to use this hidden to maturity, pejorative. The idea being when you have assets on your balance sheet, typically in finance, you what's called mark to market. Whatever the current outstanding price of that asset is, is what you need to say it is worth in your balance sheet,

Assessing Bank Run Risks and Asset Management

00:03:12 - The idea is these are assets that you have. The intent and ability according to the rules, it's supposed to be intent and ability to hold these assets until they mature. So if this is government debt, it could be 30 year government debt. So the idea is you are going to hold this asset for 30 years. You have no intent to sell it before that time is up. The reason for this, the reason that we allow these banks

00:03:46 - their cash flows. So now as prices fluctuate a little, they're not going to have to keep remarking these assets. They're not going to have to hedge these risks because they say, I don't care about this short term risk. I am just worried about this long term, problem. There's really two aspects to the model that we developed. The first aspect is really looking at what is the size of the bank run.

00:04:15 - of whatever bank you're looking at Silicon Valley Bank, or you can look at a more stable bank like PNC. We've done some, subsequent work where we've started to look at other institutions, and you can basically say, what is the run risk that they have based on how much of their deposits are uninsured, how much of it, how much of their assets are held to maturity versus available for sale? What are the quality of these assets?

Analyzing Bank Asset Management Risks and Strategies

00:04:46 - what are the risks of the run? What would happen during this event? the second aspect of the model is saying, what if we just know the total amount of assets that this bank holds? So not saying how much of it is available for sale or how much of it is held to maturity as the bank are, is reporting, but just saying, what's the sum total of the assets? And then we wanted to figure out, we wanted to study what is the, in some sense, optimal amount

00:05:20 - and ability to hold those assets to maturity. So we wanted to look at what kind of stress, so the bank has some reasonable stress so that we kind of get this idea of the intent and ability. So it's a reasonable stress scenario that hits the financial market. In the case of Silicon Valley Bank, that would be the rising interest rate environment that was prevailing at the time, to combat the inflation

00:05:49 - Based on that stress, we want to see that they would not, that no bank would have that, this bank would not have to Remark its assets, it's held to maturity assets and make them available for sale like Silicon Valley Bank was forced to do. and other banks, potentially would be forced to do. So. Again, there's the advantage to held to maturity, but we wanted to say that there's also a risk to doing it. so we try to optimize between the risk and reward.

SVB's Prudent Management and the Shift Before Collapse

00:06:25 - what we found is that up until through 2021 Silicon Valley Bank was acting prudently. The amount of held to maturity assets that they had on their balance sheet was actually below the amount that our optimization was saying that they could hold. in contrast, once we got into 2022 and early 2023 before they collapsed,

00:06:55 - to unwind that position. It was much too large an amount of health maturity. And in contrast, they were not doing that in practice. So while they were prudent, there was really, we found that there was not this big, like you could see the runup of this risk, but it was not hitting the critical thresholds ultimately at the time of the collapse that threshold was being exceeded.

00:07:26 - that there were these big risks, that were happening just before their collapse did occur. So we've subsequently, used the exact same model taking data from other banks. we've been looking at First Republic Bank, PNC, Pacific West, and a couple of other institutions, and just to try to see do similar, effects occur in banks, other banks

Assessing Bank Risk Through Asset Management and Accounting Practices

00:07:56 - or banks that did not seem to be at risk like PNC. And what we found is PNC prior to the fourth quarter of 2022, unwound, its entire held to maturity position. So they were entirely unavailable for sale. They were, according to our model, in incredibly, safe compared to, first Republic for Silicon Valley Bank, which had these growing,

00:08:30 - What this is really telling us when we look at these models, when we really try to build these constructions about risk is to look at not just, well, what's the total asset composition? But how do the banks actually do their accounting? because ultimately held to maturity versus available for sale is just accounting standards. so the way that this accounting is done really should be bank dependent,

00:09:01 - how much uninsured versus insured deposits they have. Because if most of the deposits are insured, then there is not the same risk of a run. So there is easier to have this ability to keep the assets until maturity. in practice, what we found and others have reported, the intent and ability to hold held to maturity, to maturity, seems

Regulatory Changes Post-SVB Collapse

00:09:29 - but not in practice in terms of regulatory changes that we were kind of investigating. One key, one that like jumps out that actually was done immediately after the failure of Silicon Valley Bank is to ensure all deposits. If you don't limit the amount of, the size of these accounts in, the amount that they'd be able to recover, you're immediately removing that desire to run on a bank. and actually within the United States, Massachusetts,

00:10:02 - that actually requires, insurance on all bank deposits, not just the FDIC insurance. so there are, jurisdictions within the United States that do actually prevent such a, problem. But Silicon Valley Bank, famously, primarily in California, does not, is not subject to Massachusetts, law. but otherwise it really comes down to, and it's hard to judge what intent

00:10:47 - But since they are the official rules for when you should be doing held to maturity, accounting, there should be some way to actually, check whether someone can have that intent and ability, to follow the rules and regulations.

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