In the latest episode of the All Else Equal podcast, finance professors Jules Van Binsbergen and Jonathan Burke delve into the timely subject of bank failures. They explore the foundational purpose of banks, questioning the current system's feasibility and offering a thought experiment to illustrate the instability inherent in banking. This discussion highlights the fragile nature of banks, drawing parallels with other financial vehicles and examining why bank runs occur.

The podcast extends the conversation to potential solutions for the banking sector. The hosts argue for narrowing the mismatch in risk between deposits and investments, implying a shift towards more stable banking practices through long-term investments or by modeling after mutual funds. They scrutinize the historical reasons for banks' existence, the role of insurance, government guarantees, and why banking continues in its current form despite possible alternatives that avoid systemic risk.

Main takeaways from the podcast:

Please remember to turn on the CC button to view the subtitles.

Key Vocabularies and Common Phrases:

1. arbitrage [ˈɑːrbɪˌtrɑːʒ] - (noun) - The practice of taking advantage of a price difference between two or more markets, deriving a profit from the imbalance in prices. - Synonyms: (hedging, profiting, speculation)

From an individual investor's perspective, it seems like it's close to an arbitrage.

2. yield curve [jiːld kɜːrv] - (noun) - A line that plots the interest rates, at a set point in time, of bonds having equal credit quality but differing maturity dates. - Synonyms: (interest rate curve, bond rate line, interest schedule)

They had taken positions in long term securities like treasury asset backed securities and so on, largely because if you saw what was happening to the yield curve, which is what they would get in these investments, the yield was much higher for longer run Treasuries.

3. venture capital [ˈven.tʃər ˈkæpɪtəl] - (noun) - Capital invested in a project in which there is a substantial element of risk, typically a new or expanding business. - Synonyms: (startup funding, private equity, investment capital)

These same people tout Silicon Valley and venture capital

4. narrow banking [ˈnæroʊ ˌbæŋkɪŋ] - (noun) - A proposal for banking reform that restricts banks to only invest in low-risk, short-term government securities to protect depositor's funds. - Synonyms: (cautious banking, risk-free banking, conservative banking)

This is also sometimes called narrow banking, meaning we don't have this system where you promise depositors this full promise of there's no risk, while at the same time taking a lot of risk with your investments.

5. mark to market [mɑːrk tə ˈmɑːrkɪt] - (noun) - An accounting standard that values an asset based on its current market price rather than its book value or original cost. - Synonyms: (current value accounting, fair value accounting, market value appraisal)

Now what is interesting in banking is that even though that's the value of the security, that's mark to market value, right?

6. treasury [ˈtreʒəri] - (noun) - Relating to government bonds or other financial securities that are mediums through which the government raises funds. - Synonyms: (government bonds, public securities, federal bonds)

They had taken positions in long term securities like treasury asset backed securities and so on.

7. liquidity [lɪˈkwɪdəti] - (noun) - The availability of liquid assets to a market or company, or the ease with which an asset can be converted into cash. - Synonyms: (cash flow, solvency, liquid assets)

They get their funds primarily from deposits who are promised a low interest rate. And the funds that the banks take, they invest in long term, potentially illiquid securities or loans.

8. structured models [ˈstrʌkʧərd ˈmɒdəlz] - (noun) - Financial setups where investments are made according to a pre-defined structure, often to manage risk and gain returns systematically. - Synonyms: (organized frameworks, systematic approaches, planned structures)

Alternatives such as narrow banking and structured models similar to mutual funds provide robust, less risky options for managing deposits and investments.

9. subsidies [ˈsʌbsɪdiz] - (noun) - Financial support from the government to assist a business sector, which can lead to market distortion. - Synonyms: (grants, financial aid, government support)

Current bankers live off those government subsidies and because of that they're greatly opposed to changing the system to make the economy more stable and B less government taxpayers expenditure

10. solvency [ˈsɒlvənsi] - (noun) - The ability of a company or organization to meet its long-term financial obligations and continue operations. - Synonyms: (financial health, liquidity, financial stability)

Part of what is so interesting about your working paper is that when you looked at banks and you looked at their solvency, Silicon Valley banks didn't look that bad.

Ep23 “When Banking Fails” with Amit Seru

Hi, I'm Jules Van Binsbergen, a finance professor at the Wharton School of the University of Pennsylvania. And I'm Jonathan Burke, a finance professor at the Graduate School of Business at Stanford University. And this is the All Else Equal podcast. Welcome back, everybody. Today we're going to do a special episode because we thought that there's a recent topic that really deserved some discussion. We've seen several banks fail in the last couple weeks, the last couple days, really. And so we want to do an episode in trying to understand what banks are for. Why do we have banks? And actually go even deeper and ask the question, do banks, the way they exist today, still make sense?

You know, Jules, we should also say that we had actually planned an episode on banking and we're really just moving this episode up. So the issues that we'll talk about today we had planned to talk about anyway, but I think it's very topical right now. And let me start with a thought experiment because I think it's a pretty useful thought experiment. Let's say we had a fund, an investment fund, and this investment fund made the following advertisement. You could put your money into the fund. The investment fund funds investment risky investments, but the fund will allow you to take out your initial investment at any time at par. In other words, if you invest a dollar, you're allowed to take out your initial investment at a dollar. If you don't, you earn dividends. But at any time you could take it out at $1.

How would that investment fund work? Would that be a very popular investment fund? Let's first be realistic about what's happening here. We are promising to investors that they can always take their money back at the which suggests that there's no risk involved in the investment that they make. At the same time, the investment that they're making is a very risky one. Say they put their money in mortgages that could default, or they put their money in long term treasuries or equities or whatever you're thinking about in terms of risky investments. It seems pretty much impossible to me, Jonathan. It's a or else equal mistake.

From an individual investor's perspective, it seems like it's close to an arbitrage. Look, I can't lose money and if things go well, I make money. But obviously an individual investor will realize there's only a limited amount of money in the fund. So if any one investor could take their money out once enough investors have taken their money out, if the. If the fund loses money, once enough investors have taken their money out There'll be no more money left. And those investors who haven't taken their money out will find they've lost everything. Everybody understands that. So the optimal thing to do is if you think the fund is underwater, you should take your money out first. Because if you wait, other investors will have their money out and then you'll be left with nothing in your investment. So this investment fund has this very unstable characteristic.

I just have to think this fund itself doesn't even have to lose money. I just have to think there's a possibility and I'll withdraw my money because I know that if other people withdraw their money, I might be left with nothing. And what you just described, Jonathan, is what we call a run. And in many ways, the fund we just described has some eerie similarities to the way that banking is done today. I wouldn't say eerie similarities. I would say that's exactly what a bank is. It's close to what a bank is. But there are a few differences, right? Banks don't only fund their investments with deposits. They also have a little bit of long term debt, what we call corporate bonds. They also have a little bit of equity where the owners of the bank also provide some capital into the bank.

But indeed the majority of the bank is financed with deposits. And they have exactly the characteristics that you just described. And therefore, when people think there's something wrong with this fund, with this bank, they want to be out first. And that's what we call a bank run. What makes this investment vehicle a terrible idea is the instability. It can easily be the case that in fact, all the investments are doing very well, but a rumor starts that they're not. And that would be enough for me to withdraw my money, because I would think to myself, if I don't withdraw and other investors do, I will be left with no money. And so I need to jump in first.

The characteristic of this fund that you can withdraw your money at par, you can withdraw your money at the amount you invested creates this incredibly unstable fund. In general, a far better idea is to say you only can withdraw your money at the current value of the fund, just like a mutual fund, for sure. So that if the investments that the fund makes have dropped in value a lot, you can pull your money out, but you proportionally take the loss for the investment losses that the fund or the bank has made, that would be much better. But to come back to the point you made earlier, which I think is important, particularly in the current day and age of social media, it's never been easier to start

A rumor as it is now that is widespread and reaches a lot of people in a very short period of time. So in terms of the instability, it's almost a miracle that we haven't seen more bank runs recently. I think absolutely, it's an incredibly unstable system and I would argue a system that is archaic and a system that we should not continue. So to come back to what you said earlier, why don't we see runs on Apple? Why don't we see runs on PG&E, why don't we see runs on Enron? We saw that PGE and Enron went bankrupt. But what really happened was the investors in these companies just have to come to grips with the fact that if you invest in risky things, you may lose money, you may in fact lose everything. The key difference is all investors are treated the same. Investors who arrive at the post first are not treated differently to investors who arrive at the post last. And so no investor has an incentive to run to the post.

The problem with the bank is if I come to the post first, I get all my money back and the guy who comes last gets none of his money back. When you invest in Enron, everybody gets the same haircut. So there's no incentive to run on Enron. And that instability makes a bank a pretty stupid way to running an investment account. So now then, let's go a little deeper into if it's such a bad idea, why do they exist? So is maybe an explanation that in the past there was no better alternative? I think the reason banks exist is historical.

That many like 500 years ago, one of the things that was difficult to verify was trusted. If you were going to give somebody your money and you didn't fully have a. You didn't have a legal system and you didn't have a lot of trust, that person had to give you a lot of assurances that he wouldn't just steal your money. And one way of giving that insurance is to tell you, look, you could take your money off at any time. And so I think that's the original reason we have banks. But in today's world, we don't need that. We have trusted institutions. We don't need to create an institution with that instability. If an investor can come to you and ask their money back at any point in time, you can think of that as having a lot of disciplining effect on the person who runs the bank. Because you are going to be very careful with what you do with the money.

You're going to be very careful in what you Invested in. Because you know that if people find out that you're doing things that are not so good, then people can just pull out their money instantly, and then that will be the end of your bank. So this threat of the run could actually then be used for something positive. It has a disciplining effect, right? That's exactly right, Jules. And so I would say that what happened in the interim is we started to develop institutions to make other forms of investment possible. For example, take an equity investment. When you buy stock in a company, I mean, in some sense you would think, how could this ever work? You give the company money, and then the company says, in return, we'll pay you a dividend if we feel like it. You would think, why would they ever feel like paying me money? And of course, the answer is that you have a board of directors that represents the equity holders and they get to decide what the dividend is. But of course, the problem with that is the board of directors might be dominated by large shareholders, and they may exploit the small shareholders.

And so you have a system that develops, which passes laws that limits the ability of large shareholders to exploit small shareholders. And in the end, you have a system of financing called equity that works very well. So coming back to the question is, if we want to have a bank, what are the two solutions to create a bank that would be impervious to bank drivers? What are the two solutions that create a bank that makes sense? Well, so there are two ways to do it. One is to just say, let's match the risklessness of the deposits that people put in. Let's match that with investments that are equally riskless, meaning that indeed the bank at any point in time will be able to pay back the deposits whenever they need to be.

This is also sometimes called narrow banking, meaning we don't have this system where you promise depositors this full promise of there's no risk, while at the same time taking a lot of risk with your investments. Instead, you simply invest the money in equally riskless securities, say short term treasuries. And then the second solution is you give up on the idea that depositors can withdraw their money at par. You say, okay, the bank is investing in risky securities, but if you want to withdraw your money, you have to withdraw your money at whatever the value of the bank is. We actually have this system today. We call it a mutual fund.

When you want to withdraw your money from a mutual fund, you're only able to withdraw the money at the current value of the mutual fund. So if you put Your money in the mutual fund and the shares drop in value, you get to withdraw your money at the drop value. And so no shareholder has an incentive to run on the mutual fund. We can even make it more general. We have this system, which is equity financing of any regular firm. You can put your money in, but if you want to pull it out, you'll have to sell it to somebody else at a lower price if the value of the firm dropped in value. Exactly the standard way we finance investments.

This archaic way of financing banking is somewhat puzzling. Why does it continue? I mean, why do we still have banks? One explanation is, of course, that people started to convince themselves that it was important that the depositors should be reassured that, in fact, they could always pull their money out at par. And that to prevent a run, we needed to put different systems in place that would keep them with their money in the accounts.

And one way we did that was by having the government provide insurance. And there are various different ways in which you can provide insurance. We have what's called FDIC insurance, federal deposits insurance. You guarantee a certain amount to the depositor, say, up to $250,000. But there's another way in which the government is implicitly guaranteeing things. Because we have been talking a lot since the financial crisis about bailing out banks if they are not doing very well.

So you could have a system where you could either say, let's have a narrow bank where the bank promises a riskless investment in their depositors, and at the same time only invest in riskless investments so that the riskiness is matched. Or you could say, no, keep doing this. Keep promising depositors a riskless investment. They can pull their money out apart anytime. But keep investing in risky securities, and instead, we'll have the government insure it. So the government then ensures the downside. That's a pretty good deal for bank equity holders, because the way that works is if things go badly, they're not on the hook, the government pays out, and if things go well, they keep the profits. Hence, I win, tails, you lose.

Exactly. And that's why I think we see modern banking. The reason we have modern banks is that bankers are heavily subsidized by this government guarantee. And frankly, Jules, as a taxpayer, I'm sick and tired of paying for Jamie Dimon's private jet. People want to have it both ways.

On the one hand, they argue, without banks making risky investments, the whole economy would go down. And on the other hand, they say it's very important that we offer depositors risk Free deposits. But the whole point is that you cannot have banks with riskless deposits and have them heavily invest in risky projects in the economy without having some sort of a guarantee system or some sort of support system. And so the question is, how much merit do these arguments have? Is it really the case that if we wouldn't have banks make these loans and make these risky investments, would the economy really suffer? And I think that a lot of things that you said earlier and that we discussed earlier already indicate that maybe it isn't such a big problem. Because we've gotten quite used to the idea that investors put money in risky things and take hits when those risky things don't work. They're called corporate bond contracts, they're called equity contracts, they're called through mutual funds to all kinds of vehicles.

People today are heavily investing in risky projects and taking the hits when they don't pay off. I mean, what's so ironic is that the same people that claim that these banks offering depositors the right to withdraw at par and investing in risky securities are so vital to our economy. These same people tout Silicon Valley and venture capital. If the banks were so vital, why would venture capital be used?

I mean, in other words, we have perfect examples of financing, of risky investments, of new startups or small companies, and yet on the same time they claim these banks are vital. I just find it very difficult to believe. If we had an entity like a bank which wouldn't take deposits, it would take investment capital that would be long term, and you could not withdraw that capital at par, and those entities would then invest in small businesses. I cannot see why those entities would do any worse job than what we currently call a bank. And they would not put the entire economy at risk. Now, you're so right about that, because one of the puzzles that we have in finance, in the empirical literature on finance, is how little debt, particularly these types of growth firms, these young enterprising firms, how little debt they use. And so are they really so dependent on bank loans?

Would we really not have all that economic growth and all that entrepreneurial activity without bank loans? Probably we would still have the exact same economic activity. So we need to have more evidence to support the idea that without banks making these investments, the economy would really suffer. And just to be clear, we're not advocating getting rid of what people call relationship banking. We could still have entities that are in small towns financing small firms. It's just those entities should not be financed with deposits that you can withdraw at par. Those entities should be financed just like all other risky investments with long term capital, either equity or long term debt, that way match the riskiness of the investments with the riskiness of how the investments are financed.

So we're not advocating we get rid of the relationship banking system we have, we're advocating we have to get rid of the way we finance it. Because the current way of financing it is basically a huge subsidy for bank equity holders and I would even say for bankers themselves, because a large part of the subsidy goes in banker salaries.

To say it even slightly differently, we just have to be upfront to investors all the time what the risks are that they're taking. And so by people putting deposits in banks, they are being misled because you're being told that your deposits are riskless while the investments are risky. And the only way to make good on that promise is by having an expensive government insurance system in place with a subsidy system in place. Without that subsidy system, people should be much more aware that the investments that they have are risky. And in fact, let's be clear, even with the insurance system having to go through, your bank being shut down and you not being able to access your deposits for a while is not exactly pleasant thing to go through, right?

No, I mean, I think the only logical explanation why this obviously better solution has not been adopted and instead we have a solution where the government bails out banks, is that it's not in current bankers interests. Current bankers live off those government subsidies and because of that they're greatly opposed to changing the system to make the economy more stable and B less government taxpayers expenditure.

So I think the time has come now to basically end banking as we know it. To add one more point to that, you could say why isn't it just that we see new entrants in the market? Because if banks are so uncompetitive, why aren't there just new forms of financing that are better able to do this? But the point is exactly as you made it. If a particular industry is heavily government subsidized, that's going to deter entrants. Because it's almost impossible to compete with these old banks because they're so heavily government subsidized. And so without participating in that same system in which you receive the subsidy, you can't really compete with them. And so that keeps that system in place. The competitive market can't fix this. Exactly. Because the competitive market has been distorted by the government subsidy that is in place.

Well Jules, up to now in discussing this subject, we've just basically stayed on a pretty abstract Level. But I'm sure most of our listeners are interested in exactly what happened in the latest banking crisis, exactly what happened to Silicon Valley Bank. So for that reason we've invited my colleague Amit Saru, who's the Stephen and Roberta Denning professor of Finance at the Graduate School of Business at Stanford to come on. Amit is an expert in this area. In fact, he released a working paper that he'd been working on for a couple months on exactly the issues that brought Silicon Valley bank down. Amit, welcome to the show. Thanks for inviting me.

Thanks a lot, Amit. It's great to have you. So maybe it's useful if you can explain a little bit what in your impression has happened and what the role of the increase in interest rates that we've recently seen has played in the fact that several banks are now in trouble. So as you all know, when banks get their funds, they get their funds primarily from deposits who are promised a low interest rate. And the funds that the banks take, they invest in long term, potentially illiquid securities or loans. And because these are long run, they earn a higher interest rate. And the spread is what bank makes. And in normal times that spread is a very high return on investment for equity holders which are tiny part of the liability side.

So that's how a typical bank works. And all well and good. Over the last few years as the interest rates had gone down and a lot of deposits had come into the bank, the question was what were the banks doing in terms of investments. They had taken positions in long term securities like treasury asset backed securities and so on. Largely because if you saw what was happening to the yield curve, which is what they would get in these investments, the yield was much higher for longer run Treasuries, longer run RMBS asset backed securities. So the banks were hoping that they get their deposits, they pay them, let's say 1% and they are going to put it in the long term supposedly safe securities and get a higher return, especially in the long run securities.

And that was all well and good till the time Fed started raising the interest rate because as many of us have noticed, inflation went up. So at some point Fed had to raise the interest rates and now suddenly you saw a spike in the interest rates. And when the interest rates spike, that clearly has an effect on the value of the securities. And what it did was it reduced the value of the securities. Now what is interesting in banking is that even though that's the value of the security, that's mark to market value, right? If you had to take the security to the market, what would the value be? The value would go down. But they don't have to sell those securities. They only need to sell those securities if the folks who gave them money ask for it right now.

Now remember, these are the same folks who are not asking for a high rate and bank is probably giving them 0.5% or 1%. Think about your own checking account, how much are you getting? Still 0.5%. So banks were fine. They were like, yeah, interest rates are going up, but we don't need to worry about this. But interest rates going up clearly depressed the mark to market value of the asset side. And then the question is, is there going to be an event which is going to force the bank to take these securities to the market and as a result take a loss and income? Silicon Valley bank, where this kind of event did happen.

So Silicon Valley bank had had a huge inflow of deposits about, I think the number, if I remember correctly, is $140 billion had flown in in terms of deposits over the last year and a half. And all of them were primarily in these kinds of long term securities. And suddenly as the startups who were actually the ones who had actually invested and given a bunch of deposits to Silicon Valley bank wanted to draw down on their cash because they were running out of cash. If everybody's noticed, the economy has slowed down, they needed more funds to keep going and they asked Silicon Valley bank to basically give them their deposits, not because they were expecting higher rates, but just because they needed money.

That event itself was enough to force Silicon Valley bank to liquidate some of these securities whose value had fallen. Once that happened, they had to come out and say, okay, we have taken a loss on these securities that we have been now selling. And an aha moment happened where everybody suddenly realized that, oh, there is a bunch of these securities that banks have, these investments that bank have, which actually are pretty sensitive to interest rates. And interest rates have risen by 3%. And if the interest rates rise by 3%, anybody who has taken an investments class, or even if they have not taken an investment class, you should know that if interest rates go up by 3%, that's a huge change in the value. Your value drops dramatically. So now what do we do?

We are left with trying to persuade all the depositors that yeah, this is just a small blip because we have enough money, it's all tied up in these long term securities for five years or seven years. And all you need to do is just stay tight. If you don't ask for money, we are all good. And you know that statement is correct because the investments are in long term Treasuries in long term asset backed securities. But the one thing that we have learned from bank runs is that once they start or once there is a doubt on the solvency of the bank, it's very difficult to persuade the depositors because everybody understands that if they are not first in queue, they might be left holding hot potato in the end.

And in this case the event was triggered by the fact that Silicon Valley bank had this money coming in from Silicon Valley, which is a pretty tight knit community in the sense that venture capitalists all kind of know each other. So there's correlation in how their deposits behave. So they all come in together and they all leave together. And not only the money coming from venture capitalists, but also the portfolio companies that they had invested in because they are supposed to be advising them what to do with their cash. So you saw the news where a lot of these venture capitalists went out and told their portfolio companies that you need to be sort of careful about this.

So the depositors, which are supposed to be sleepy, that's how we pay them, 0.5% forever, while the market rates might be anything, suddenly woke up. And they woke up because they were all connected. And once they woke up, the bank now is forced to sell even more securities because that's the only way they can pay it back. And you're now in a vicious circle where all my long term investments as my Silicon Valley bank have to be liquidated. And if I have to liquidate all of those assets, I'm done. Because the value of these securities with the high interest rates is really, really low. Part of what is so interesting about your working paper is that when you looked at banks and you looked at their solvency, Silicon Valley banks didn't look that bad. I mean they weren't good, they were like in the 9th percentile. But they weren't at an extreme yet. They were picked on.

And what you explain in the paper is the relevant thing to look at is not so much the solvency, but the fraction of deposits that are insured by the fdic. In other words, if I know my deposit is under 250, I don't care. I'll get the money no matter what. But if it's over 250, I need to act and get it out of there. Explain that to us.

So the key here is, are the depositors sleepy or not? So when do they wake up? And if you look at the banking system. So the banking system is $24 trillion. So it used to be $24 trillion. I don't know what the value is now. Slightly lower, but right, $24 trillion. And if you look at the equity in the aggregate banking system, it's like $2 trillion. The rest is pretty much deposits. Half of them are insured by fdic, half of them are uninsured.

So these are large deposits above 250,000. Corporations invest their money with the banks, venture capitalists put in their money, portfolio companies or venture capitalists put in their money. And you know, typically when we talk about depositors being sleepy, we lump all of this together. But let's remember, 50% by value is not insured. And now an event occurs where bank takes a huge loss because interest rates went up. And the point of the paper was to say we can't assume that all of these depositors are going to be sleepy because in fact they are very active and they are going to show up at the bank way faster than those who think that their deposits are still going to be protected by fdic.

And that would not be a bad assumption because that's how historically it's happened. So you got to be very careful about what's the proportion of uninsured depositors in the depositor composition. And Silicon Valley bank was at the extreme right. So you're exactly right. If you looked at the losses, it was not in the extreme. Yeah, it had a reasonable set of losses, but a lot of banks were doing that. There were some worse banks too. But what it was really extreme on was it had a bunch of these uninsured depositors very high. 97% of their depositors were uninsured.

And they were all correlated. So if one woke up, they woke up the whole 97%. And in three days they had one third of their deposit just leave, which is a very fast movement out of a bank and no bank can survive that.

So, Amit, isn't another way of interpreting your work as saying the word sleepy is the wrong word. People don't move their deposits out of banks and they accept low interest rates because there's a lot of transaction costs and there are a lot of issues to move money, but it's not because they're asleep. And then if it turns out they could actually take big losses, then those transaction costs become very small and they are very active when it comes to moving money out. Isn't that one way of interpreting your work?

It is. And basically the paper you're referring to says instead of just looking at Silicon Valley bank, suppose you were to stress test the whole banking system. That's what the paper has done. And asked, what do you see in terms of how many banks will be able to sustain such a run if it does happen? And how many banks would not be able to?

So Amit, given all of that and the stress test that you just introduced, I'm somewhat surprised that particularly since the financial crisis in 2008, stress testing became something that everybody was busy with. And then at the same time, the Fed who's involved in this is the one who is raising these interest rates. Have these stress tests missed out on the possibility of correlated deposits in combination with rising interest rates leading to this problem? How could this be missed?

So I think that's where the title of the podcast that you have is very relevant. When we do these things, we take all else as being equal and it's not. So my preferred way of thinking about why this might have happened is regulators, whoever it might be. And we are talking about pretty sophisticated regulators. They designed the stress test to address a particular situation that had happened in 07 08. And we had different scenarios, pretty tough scenarios, but we were going to be looking at certain things like default rates on loan portfolio and all the kind of things that had happened in the 0708 crisis.

Fast forward. And we went to a regime of very low interest rates and now are going into a regime of very high interest rates. The type of risk we are talking about is very different. We are talking about an interest rate risk that is not what happened in 07 08. So if I had to take a guess, the stress test in general will do a great job telling you what the credit situation of the loan portfolio would be. And I still don't see the defaults going up. So that seems reasonable.

But what they didn't do a great job was to look at what would happen to the other parts of the portfolio, which could actually be pretty sensitive to the kind of things that are happening in the macro economy. And if you don't understand the whole picture at all times, that's the problem, that all else does not remain equal and even very sophisticated actors and players might miss out on the effects.

But don't you think that we always miss out on the next thing that happens? Exactly. For that reason, are we not always risk managing the last crisis and never managing the crisis that's coming ahead of us? So that makes you wonder how useful this way of approaching the problem is. There is always a debate about ex ante regulation versus ex post regulation. Right. So my time, having spent enough time thinking about this in the banking space is regulators have a role to play, but I think we cannot substitute something like a huge amount of equity, which is another way of saying that you're moving towards a narrow bank. Maybe you want to take risk, go ahead, but then you need to internalize the costs you as in being the bank. So once you do that it becomes easier because the actors taking the risk are going to be internalizing whatever is happening.

And regulators might do something on the margin, but they will not be the sole drivers of the direction in which the banking or the credit or the risk or how it's getting allocated is going to be decided. We are going to let the market participants do it and they can internalize the risk in their own way. Definitely.

Thank you very much, Amit. We really appreciate you coming on the show. Excellent. Thank you both for inviting me and we'll put the working paper in the show notes for anybody who's interested in seeing it.

Finance, Economics, Technology, Banking Crisis, Silicon Valley Bank, Market Instability, Stanford Graduate School Of Business