Why the investor brain was hardwired for banking at SVB, Signature

The panic-induced customer withdrawals that imploded Silicon Valley Bank and Signature Bank — sending shockwaves through financial markets and the broader banking system — offers an acute lesson in human psychology.

In this case, an understandable “behavioral bias” led to poor financial results, experts said.

“Psychology injects a lot of extra risk into the world,” Harold Shefrin, a behavioral economics expert and finance professor at Santa Clara University. “And we saw that risk last week — from Silicon Valley Bank and the reactions of its depositors.”

Our brains are wired for a bank run.

Humans evolved as social creatures that thrive in groups, said Dan Egan, vice president of behavioral economics and investing at Betterment. As such, we care a lot about what others think and do.

So we run if we see others running — a practical impulse when it meant life or death for early humans fleeing bears and lions, but one that may not make sense in the modern era, Egan said.

Last week, bank customers saw their peers running for the exits; sensing danger, the herd mentality meant they also rushed to withdraw their cash. But banks don’t have customer deposits on hand; they generally invest or lend them to make money. SVB and Signature did not have enough cash to meet redemptions.

Fear among the collective group became a self-fulfilling prophecy: It triggered a bank crash, the very problem they originally feared, Egan said.

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There are firewalls against this kind of behavior. The Federal Deposit Insurance Corporation, or FDIC, freezes bank customers’ savings up to $250,000.

This insurance program was created in 1933. By then, widespread hysteria during the Great Depression had brought down thousands of banks in rapid succession.

FDIC insurance is intended to instill confidence that the government will make customers whole—up to $250,000 per depositor, per bank, per ownership category – if their bank goes bankrupt.

“Prior to the creation of the FDIC, large cash demands from fearful depositors were often the fatal blow to banks that might otherwise have survived,” according to a chronicle of its history.

SVB’s client base included many companies such as technology startups with a high level of uninsured deposits (ie, those exceeding $250,000). As of December, about 95% of the bank’s deposits were uninsured, according to SEC filings.

Its failure illustrates a few principles of behavioral finance.

One is “information asymmetry,” a concept popularized by economist and Nobel laureate George Akerlof, Shefrin said. Akerlof, spouse of Treasury Secretary Janet Yellen, analyzed how markets can crash in the presence of asymmetric (or unequal) information.

His 1970 essay, “The Market For Lemons,” focuses on the market for old and defective used cars (colloquially known as lemons). But information asymmetry applies across many markets and was a source of Silicon Valley Bank’s collapse, Shefrin said.

The bank said March 8 that it sold $21 billion worth of securities at a loss and was trying to raise cash. That announcement sparked panic, amplified by social media. Customers saw peers rushing for the exits and didn’t have the time (or perhaps the acumen) to pour over the bank’s financial statements and assess whether the bank was in serious trouble, Shefrin said.

Rational market theory predicts that customers with uninsured deposits — the majority of their customers — would move to protect themselves and secure their savings, he said.

“If you have more than $250,000 in the bank, in the absence of information, you have to assume the worst,” Shefrin said. “And unfortunately it will be rational for you to participate.”

Hence a bank run.

But the same rationality does not necessarily apply to bank customers whose deposits are fully insured but since they are not at risk of losing their money, experts said.

“If you have less than $250,000 and you don’t need to make payroll or feed your family, there’s no need to rush,” said Meir Statman, a behavioral economics expert and finance professor at Santa Clara University. “In this case, (withdrawing your money) is not the rational thing or the smart thing to do.”

Bank officials also exhibited a psychological “failure” in their initial announcement of their need to raise money, Shefrin said. They did not understand the concept of “market signaling” and failed to foresee how their communication of information could trigger panic, he said.

“If you don’t rationally understand the way the market interprets signals, you can make a mistake like Silicon Valley Bank,” Shefrin said.

Fear among depositors also appears to have been fueled by behavioral bias, Egan said.

Storing all deposits in a bank with like-minded tech founders could mean customers experienced the same fears at the same time, akin to an echo chamber, he said.

Diversifying any savings that exceed $250,000 across multiple banks — so no one account exceeds the FDIC insurance limit — is a rational solution to alleviating stress and fear, Egan said.

The Biden administration stepped in on Sunday to allay concerns among depositors. Regulators stopped all uninsured deposits at SVB and Signature Bank and offered funding to distressed banks. Eleven Wall Street banks on Thursday injected $30 billion into First Republic Bank, a smaller player that appeared to be on the precipice of collapse, to help bolster confidence in the banking system.

Given the recent government backstops, there is “no reason” for depositors to run for the doors, said Mark Zandi, chief economist at Moody’s Analytics.

“But confidence is a very fickle thing,” Zandi said. “It’s here today, gone tomorrow.”