Tomasz Piskorski, Edward S. Gordon Professor of Real Estate, Finance Division, Columbia Business School
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00:00Welcome everybody, glad to be here. I'm a professor at Columbia Business School. I
00:05do a lot of work on financial intermediation, banking, fintech, and real
00:09estate, and recently, along with my colleagues, I've done quite a lot of work
00:12on financial stability and drawing lessons from the recent bank failures
00:17such as the Silicon Valley Bank I would like to tell you a little bit about. So
00:22let me tell you our view. What we think is one of the main sources of risk
00:26currently in the US financial system. From our perspective, it's really the
00:31fact that banks have very high leverage. If you look on a typical bank in the
00:37United States, and there is really very little variation, whether you're a small
00:41bank, whether you're a large bank, banks are essentially about 90% debt funded
00:47and only 10% of equity. So think about what it means. Consider, for example, a
00:52situation when there is a modest decline in the value of bank assets, let's say
00:5710%, that already potentially put these institutions at the brink of
01:01insolvency, because the value of the assets will be less than the face value
01:06of the liabilities. And if you look on the banking sector as a whole, you know,
01:12this is a 24 trillion dollars of assets. On the asset side, banks take a lot of
01:16duration risk and credit risk. They give a lot of assets like securities, long-term
01:22treasuries, long-term mortgage-backed securities. In addition, they have
01:26real estate loans, including commercial real estate loans, and other loans
01:31like corporate loans with a credit risk. And the way they finance it is
01:35essentially with short-term debt. Most of these debts are deposits, about 18
01:41trillion of them, and about half are insured by FDIC and half are uninsured.
01:46These are deposits above $250,000. And in addition to that, the banks have
01:51fairly thin equity cushion. So you can see, this is a pretty fragile system with
01:58very little equity financing and a lot of debt financing. And in that sense, the
02:03recent monetary tightening illustrates this point. The Fed raised interest rates
02:07very aggressively, and essentially in a matter of a year, they went from 0 to 5%.
02:12What it means to the value of long-duration assets, there has been a
02:17very big decline in the value, including U.S. treasuries and so on. If you look on
02:21long-duration assets, long-term bonds, they decline by, you know, in the order of
02:2530%. So when you take this decline, the market implied decline in the value of
02:31assets, and apply it to bank balance sheets, what you will find is that in the
02:36aggregate, the value of the bank assets right now is about $2 trillion less
02:41relative to where it was at the beginning of the Fed tightening cycle.
02:46And in fact, there's quite a few banks in the U.S. right now, and Silicon Valley
02:50Bank was one of them, that currently have the value of their assets, the market
02:55value, being less than the face value of their debt. So in principle, if the
03:00depositors would show up, this bank would fail, unless of course regulators step in.
03:05Now, I'm not trying to say that all these banks will fail. It depends on your
03:09funding, and in particular, it depends what portion of your funding is unstable,
03:13especially uninsured deposits, because uninsured depositors can lose money if
03:17the bank fails. And, you know, in that sense, you know, the Silicon Valley Bank was an
03:21outlier, that 80% of its assets were financed with uninsured deposit.
03:27Essentially, Silicon Valley Bank had just uninsured deposit funding, so it's very
03:30fragile in that sense. And the question is, you know, and the mechanism is as
03:35follows, you know, the interest rates go up, you can add to this credit risk, bank
03:39asset values decline like they did, uninsured depositors get spooked, they
03:44see these big declines in asset values, they worry about solvency of the bank,
03:47they start withdrawing money, and then you can end up with a run equilibrium.
03:51The key question, and I was talking a lot with regulators about that, is how
03:56special is the Silicon Valley Bank? Are there other banks like that? And the
04:00short answer is yes. There is quite a few banks in the United States right now
04:04that have very similar risk characteristics. Now, they're extreme as
04:08Silicon Valley Bank, but you can support a run on them. They are actually at the
04:12risk of run. And this is just the duration effect. If you add to this
04:18credit risk, remember that for a mid-size banks, about 25 to 30 percent of the
04:23assets are commercial real estate loans. With that analysis, loan by loan, 14
04:28percent of these loans are underwater, meaning the property value is less, worth
04:32less currently than the face value of debt. If you look on office loans, it's
04:3644 percent. So in addition to this duration risk, there is also a credit
04:40risk that would enlarge the set of banks that could potentially fail. So the
04:45obvious question is, and you know, talking all the time of this with regulators, you
04:49know what to do about it. And one natural answer is, well, let's raise the bank
04:53capital requirements. Maybe not right now. Once the things come down a bit, that
04:57would make the system more safe. But the obvious question is how much leverage
05:01financial institutions really need to provide efficient functions like
05:06originating loans and doing other things. And in fact, we have a window in it. We
05:11compare the leverage of banks to non-bank lenders. The black curve shows
05:16you the non-bank lenders. These are the institutions that make loans like banks.
05:20This is in the mortgage market, but don't have access to insured deposit funding
05:24and are lightly regulated. And guess what? In this private market benchmark, without
05:30access to insured deposit funding, these institutions have much less leverage and
05:34much more equity funding. And the lesson we draw from this, you can be a pretty
05:39good lender with much lower leverage. And what's interesting is the biggest
05:44discrepancy is actually for smaller and mid-sized banks. What it means is, let's
05:49say the JP Morgan, their leverage is pretty close to what they would have
05:53been levered even if they wouldn't have access to insured deposit funding. It's
05:57precisely the smaller and mid-sized banks, including banks like Silicon
06:01Valley Bank, that were levered much more and because of this implicit and
06:06explicit guarantees. You know, Silicon Valley Bank did not have much insured
06:10deposit funding, but there's a lot of other banks that do and take advantage
06:13of that. One, of course, thing is that, you know, if you talk to bank CEOs, they
06:19will tell you, hey, if you raise bank capital requirements, the lending will
06:22collapse and we're going to have contraction of economic activity. We just
06:26really cannot do it. Of course, the answer to this question depends on how
06:29important are banks in financing credit to households and firms. And let me just
06:36tell you, they are not as important as commonly thought. In the 1970s, bank
06:41balance sheet financed 60% of lending to households and firms. So in other words,
06:46in the 1970s, banks were very important. Nowadays, bank finance only about a third
06:52of credit to house concerned firms. The rest is financed with debt securities,
06:56private credit, and so on and so forth. So in the aggregate, the banks are much
07:01less important than they were a few decades ago. And what it means, it has
07:06interesting implication for capital regulation. What would happen, we actually
07:09did a simulation, if you would raise capital requirements on US banks, well,
07:14the amount of bank balance sheet lending will drop substantially and so is the
07:19bank profits. So, you know, it's kind of understandable why some bank CEOs might
07:22not like it, but the aggregate decline in lending would actually be quite
07:26modest. What would simply happen, bank would still make loans, but instead of
07:30keeping them on balance sheet, they would sell them and there will be expansion of
07:34non-bank and private credit. So let me just conclude with some thoughts where
07:38I'm thinking it will go going forward. First, I think the banks are continuing
07:43to become increasingly less relevant, and especially smaller and mid-sized banks.
07:47We have ongoing consolidation in the banking industry. I predict in a few years
07:52we'll have much fewer smaller and mid-sized banks. I also think that we'll
07:57see a growing rise of debt securities and private credit. Private credit is
08:01rapidly increasing right now, and of course who's going to finance a lot of
08:05that, you know, vehicles like money market funds, exchange-traded funds, and so on.
08:09On the asset side, the traditional banks already lost a lot of edge. Think about
08:16the mortgage finance, which is a very important debt market. Now banks account
08:21for less than half of the lending there, and the biggest lender is Quicken Loan.
08:24Quicken Loan is currently called Rocket Mortgage. You know, they just have,
08:29you know, the platform, they don't have deposits, it's a non-bank. And, you know,
08:34impact of AI is likely to make things potentially worse for banks, as we just
08:39heard a little bit in an earlier session. I expect these non-bank financial
08:43institutions to possibly be more able to innovate in this space, especially because
08:48they are more lightly regulated. And so essentially the main value that banks
08:53currently derive is on the liability side. Is this access to insured deposit
08:57funding allows them this cheap debt, they can recycle into loans, but also in
09:01securities and other vehicles. So in some ways survival of especially mid-sized
09:06and smaller banks critically depends on continual access to this implicit and
09:11explicit subsidies, and if the regulators decide to crack it down, we will see
09:16further contraction of smaller and mid-sized banks. Bigger banks, of course,
09:21will have to innovate harder and harder to stay relevant, but they have a scale
09:25so they probably will be able to continue operating. And the last thing,
09:30even on the liability side, there are many innovations that threaten banks.
09:34Think about central bank digital currency, or alternative payment systems.
09:38If this takes the deposit role from the banks, they will be really in a precarious
09:42state, because, you know, the asset side is already very difficult for them to
09:45make money. Once they lose this deposit advantages, it will be a difficult
09:49position for them. So thank you very much and thanks for your attention.