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After SVB failure, Haas faculty raise concerns about systemic weaknesses in banking

A pedestrian passes a closed Silicon Valley Bank branch in San Francisco on Monday, March 13, 2023.
A pedestrian passes a closed Silicon Valley Bank branch in San Francisco on Monday, March 13, 2023. (AP Photo/Jeff Chiu)

As repercussions from the stunning collapse of Silicon Valley Bank (SVB) continue to ripple through the banking industry, we asked Haas experts for their views on where the system broke down and whether there may be broader trouble viewing. 

Professors Ross Levine, Panos Patatoukas, and Nancy Wallace said SVB’s problems were “banking 101” and that its management and board failed in their fiduciary duties.  Levine, a banking industry expert, said the situation “suggests stunningly incompetent bank supervision and regulation,” and cited research that Silicon Valley Bank may be “the tip of a gigantic iceberg.” Patatoukas agreed, asking  “If (regulators) cannot spot something as straightforward as SVB’s issues, then what else are they missing?” 

Professor Ross Levine, Willis H. Booth Chair in Banking and Finance, Haas Economic Analysis & Policy Group

Ross Levine
Prof. Ross Levine

“Silicon Valley Bank (SVB) failed in the simplest and most vanilla way. It had long-term assets, including Treasury securities and other U.S. government backed-securities, and short-term liabilities, namely deposits. This exposed the SVB to interest rate risk because long-term securities are much more sensitive to interest rate changes than deposits. As interest rates went up over the last year, the price of long-term securities went down, challenging SVB’s solvency.

Regulators at the Federal Reserve and the Federal Deposit Insurance Corporation (FDIC) did not need sophisticated supervisory and regulatory skills or elaborate training to recognize such interest rate risk. It is banking 101.

While new information might emerge, current knowledge suggests stunningly incompetent bank supervision and regulation. The Federal Reserve and FDIC regulators need to explain why they did not require SVB to hedge interest rate risk three years ago, two years ago, etc.

The apparent failure of Federal Reserve and FDIC regulators in the case of SVB raises questions about the effectiveness of U.S. regulatory authorities in general. First, if regulators failed to address the most basic of risks—interest rate risk—in SVB, did they miss this interest rate risk in other banks? Second, have regulators effectively addressed the more complex risks that some banks take? Third, did regulators allow systemic risks to grow in the U.S. banking system?

Recent research provides an alarming answer to whether the Federal Reserve and FDIC blew it on interest rate risk beyond SVB, suggesting that SVB is the tip of a gigantic iceberg. A study conducted over the weekend indicates that the market value of U.S. banking assets is about $2 trillion dollars less than the reported book value due to increases in interest rates during the last year. It is impossible to determine the degree to which banks used derivatives to hedge interest rate risk. Thus, one cannot conclude definitively that the U.S. banking system experienced a loss of $2 trillion. However, these statistics, in conjunction with the details on SVB, scare me.

While Secretary of the Treasury Janet Yellen and Jay Powell, Chair of the Federal Reserve Board, might claim that the U.S. banking system is very well capitalized and very well supervised and regulated, they have some explaining to do.

Recent events also raise concerns about the competency of U.S. monetary policy, which, like much of bank regulation, is conducted by the Federal Reserve. The Federal Reserve started raising interest rates a year ago to combat inflation. (As a side point, the Federal Reserve created the inflation it is now combating.) It should have been evident to the Federal Reserve that banks with long-term assets and short-term liabilities that had not hedged interest rate risk would experience significant losses as interest rates rose. Moreover, the Fed has or can obtain information on banks’ assets and liabilities and the degree to which they were hedging interest rate risk. Thus, they knew—or should have known—which banks were most exposed to interest rate risk as they started raising interest rates. As a result, even if bank regulators failed to force banks to address interest rate risk before the Federal Reserve began to raise rates, the Fed should have been aware of this vulnerability as it started tightening monetary policy to fight inflation.”

 Associate Professor Panos Patatoukas, the L.H. Penney Chair in Accounting, Haas Accounting Group

Panos N. Patatoukas
Panos N. Patatoukas

“The SVB management and board failed in their fiduciary duties. The Fed also failed in its supervisory role since it failed to spot a basic duration mismatch and a massive run-prone deposit base, together with a lack of interest rate risk management on the part of SVB. It would have been straightforward to see from SVB’s financial statements that its (tier 1) liquidity ratio was much lower after accounting for the accumulated but unrecognized losses from the revaluation of their long-term bond portfolio, which basically indicates that SVB had elevated risk well before the run on the bank.

The SVB failure raises concerns about structural problems impacting regional banks, their depositors, and capital providers. It also raises concerns about the ability of regulators to spot risks ahead of time. If they cannot spot something as straightforward as SVB’s issues, then what else are they missing?”

Professor Nancy Wallace, Lisle and Roslyn Payne Chair in Real Estate and Capital Markets

Berkeley Haas Prof. Nancy Wallace
Prof. Nancy Wallace

“This is a monumental failure of risk management on the part of both the bank and the regulators.  Interest rate risk is basic banking 101. Added to that is the very large depositor concentration from one industry. I also suspect that the loans on (Silicon Valley Bank’s) balance sheet are likely to be poorly underwritten given the overly cosy relationship between the bank and the king makers in Silicon Valley. They frequently provided loans to startups as a bridge between funding rounds.  They did this to protect startup founders from the dilution effects of additional equity rounds—the more normal way to fund startups.”


How salary benchmarking by employers affects workers’ pay

Young Asian business woman in blue suit receiving an envelope with a salary offer
Credit: iStock

A wave of pay transparency laws aimed at reducing inequities is giving millions of workers access for the first time to information on what co-workers make and what potential employers will offer.

Yet comparing salary information is nothing new for employers. While U.S. antitrust law prohibits employers from directly sharing salary information with each other, most mid-sized and large companies routinely use aggregated data from third parties to get a read on the going rates. 

The effects of this widespread practice, known as salary benchmarking, have never been systematically studied—until now. Following White House concerns that benchmarking may be used to suppress wages and benefits, a new study offers the first evidence on its impact on workers.

The conclusion: Benchmarking does not have a negative effect on pay for the average employee. While some salaries decrease and others increase after a company uses a benchmarking tool, salaries overall simply move closer to the benchmark. 

If there was a negative effect on salaries, it would be suggestive of anti-competitive effects,” said Associate Professor Ricardo Perez-Truglia, who authored the new National Bureau of Economic Research working paper with Zoe B. Cullen and Shengwu Li of Harvard University. “That’s not what we found. If anything, we see some small salary gains for low-skill occupations.”

The researchers used aggregated data from the nation’s largest payroll processing firm to see how much employers paid new hires in hundreds of job categories before and after they used the payroll firm’s salary benchmarking tool. They found that employers paid new hires much closer to the median wage after searching the market rates for those job titles.

As a result, some new employees earned more and some earned less than they would have otherwise. “For the most part, they sort of cancel each other out,” said Perez-Truglia.

Direct sharing prohibited by law

Although U.S. law prohibits employers from directly sharing information about their employees’ compensation with each other, they can access aggregated salary data from third parties such as management consultants and payroll processors. As part of the study, the authors surveyed human resource professionals who set pay at medium and large companies and found that 87.6% use salary benchmarks, usually from multiple sources.

In July 2021, Biden issued an executive order encouraging the attorney general and Federal Trade Commission to consider revising federal guidance that lets neutral third parties share compensation information with employers—but not employees—without triggering antitrust scrutiny. “This may be used to collaborate to suppress wages and benefits,” the White House said in a fact sheet.

At that time, there was no research on the impact of benchmarking. Perez-Truglia said regulators may be responding to studies and news reports suggesting that industry consolidation is giving employers too much market power when it comes to setting salaries. 

The new study, which began in 2019, looked at starting pay offered to new hires at 586 firms that gained access to the benchmarking tool between January 2017 and March 2020. The online tool is easily searchable by job title and is based on real, aggregated and anonymized payroll records of many millions of employees.

The researchers divided the new hires into two groups: nearly 5,300 new hires where the company had searched the benchmarking tool before hiring, and a “control group” of 40,000 hires in the same companies that had not been searched. They compared pay for the two groups in the five quarters before and five quarters after the company first gained access to the salary data.

As a second control group, they looked at salaries offered to about 157,000 people hired during the same time periods in comparable roles at similar companies that never gained access to the more precise salary tool.

‘Compression toward the benchmark’

They found that on average, both high and low salaries moved closer to the benchmark. Among “searched” positions, the absolute difference between the new hire’s starting salary and the median salary for that position dropped from about 20 percentage points before the firm gained access to the tool to about 15 percentage points after. This drop is “large in magnitude, corresponding to a 25% decline,” the authors wrote. 

To illustrate this “compression toward the benchmark,” suppose the median pay for a bank teller is $40,000. Without that information, one bank might pay $30,000 and another $50,000. “Once they see the benchmark information, they are much more likely to pay new hires around the $40,000 benchmark,” Perez-Truglia said.

The researchers added that “the effects on salary compression coincide precisely with the timing of access to the benchmark: The compression was stable in the quarters before the firm gained access to the tool, dropped sharply in the quarter after the firm gained access, and remained stable at the lower level afterwards.”

For searched positions, compression around the median wage was much stronger among low-skill positions, which generally don’t require more than a high school degree, than high-skill ones. Dispersion around the benchmark dropped by 40% for low-skill jobs versus 14.6% for high-skill ones. 

“This finding is largely consistent with the anecdotal accounts in interviews with compensation managers, according to which low-skill positions are treated as commodities and thus should be paid the market rate,” the authors wrote.

They did a similar analysis looking at average salary levels and found that benchmarking “does not have a negative effect on the average salary. If anything, the effect on the average salary is positive, but small in magnitude and statistically insignificant.”

Specifically, they found the average starting salary for all searched positions was either 0.2% lower or 1.7% higher than the two control groups, respectively.

There were some statistically significant gains for low-skilled employees: Their average pay increased by 5% or 6.7% depending on the control group. The study also found that the small boost in salary for low-skilled employees increased their retention. More precisely, there was an increase of 6.7 percentage points in the probability that those employees were still working at the company one year later. 

“This evidence suggests that firms may be using salary benchmarking to raise some salaries in an effort to improve, among other things, the retention of their employees,” the paper says.

For high-skill positions, starting pay went down by 2.9% or 1.6% depending on the control group, “but those effects must be taken with a grain of salt, because they are statistically insignificant,”  Perez-Truglia said.  

“Typically low-skilled employees are less likely to negotiate than high-skilled employees. They are often made take-it-or-leave-it offers,”  Perez-Truglia said.  Benchmarking could provide “more equality for those workers.”

There is also a growing body of literature on pay transparency, but much of it focuses on giving employees more access to information, usually as a way to reduce gender and racial pay gaps. A new law in California requires all private employers with 15 or more employees to provide pay ranges in all job postings starting Jan. 1. Colorado, Washington, and New York City have passed similar laws.Although employees can’t access the same kind of “super-sophisticated” pay data that employers can use, Perez-Truglia said, they can use online sources such as Glassdoor, LinkedIn, and to get a read on competitive salaries. Companies are also consulting these sites, he added, which generally rely on employees reporting their pay at current or past employers