U.S. allocates billions to banks while acknowledging that SVB’s fundamental issues persist.

Washington is currently in a benevolent stance towards its banking institutions. In March, federal regulators introduced a comprehensive revision of capital requirements (the financial buffers that banks must maintain to absorb losses during challenging periods), and the headlines were self-explanatory: deregulation, relief, billions available for lending and buybacks. The proposal aims to reduce the required capital for the largest Wall Street firms by nearly 5%.

The Federal Reserve projected that approximately $20 billion in capital could be released for just the eight largest banks. Former Fed Vice Chair for Supervision Michael Barr estimated the figure could be even higher, cautioning that the total might reach $60 billion once all related adjustments were taken into account.

Why this is significant: The stability of banks relies less on reported capital and more on market perceptions of what is genuinely available. If unrealized losses remain on balance sheets, confidence can erode more swiftly than regulation can respond, transforming a technical accounting issue into a liquidity crisis.

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However, an unexpected detail emerges upon examining the fine print. Regulators established one particular exception: certain large regional banks will need to start accounting for unrealized losses on their balance sheets, a change directly associated with the downfall of Silicon Valley Bank in 2023. This provision, largely overlooked in discussions of the broader rollback, represents a regulatory acknowledgment.

To grasp the significance, one must understand what an “unrealized loss” means for banks. Consider purchasing a ten-year government bond for $100. If interest rates rise sharply, new bonds offer higher returns, making your bond less appealing as its market value declines to, for instance, $80.

Even though you have not sold anything and incurred no cash loss, this situation indicates that you are now facing a $20 loss, unrealized and largely unnoticed by most financial assessments.

For years, midsize banks were permitted to exclude these paper losses from the capital figures they reported to regulators, as if the disparity between market value and book value did not exist.

How Silicon Valley Bank's unrealized losses led to a bank run in 2023

The collapse of Silicon Valley Bank stemmed from something far more ordinary than fraud or reckless lending: a portfolio of entirely legal long-term bond investments that lost much of their value as interest rates increased.

The initial signs of a crisis appeared in early March 2023, when SVB disclosed a $1.8 billion loss on the sale of securities, a direct result of those unrealized losses, along with a plan to raise $2 billion in new capital.

Shares plummeted 60% the next day as uninsured depositors began withdrawing their funds en masse; by that evening, $42 billion had exited the bank, with an additional $100 billion prepared for withdrawal by morning.

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Nearly 30% of its deposits vanished within hours. SVB was overwhelmed by panic, which was triggered by losses that had been present for an extended period, suddenly becoming apparent.

The bank’s capital appeared significantly more sufficient than it truly was, as almost none of its supervisors, depositors, or investors could assess the actual extent of the unrealized securities losses.

Under the regulations in effect at that time, SVB had utilized a legal and widely accessible option, choosing not to include those losses in its reported capital figures, a decision that ultimately proved disastrous.

Banks that were obligated to account for unrealized losses in their regulatory capital, on the other hand, managed their interest rate risk much more prudently. The lesson from SVB is that concealing losses of this magnitude ensures that no one will take action until it is too late.

Why the new bank capital regulations still require regional banks to report unrealized losses

This brings us back to the current proposal. The modification requiring large regional banks to account for unrealized losses will raise their capital requirements by 3.1%, although their overall capital is still anticipated to decline by 5.2% when all pending changes are taken into account.

Banks with assets below $100 billion do not face such a requirement, and their capital is expected to decrease even further. The message conveyed is clear: the issue was genuine, and it existed at a specific scale. The carve-out serves as Washington’s way of indicating, in its typically detached bureaucratic language, that SVB’s failure was a result of poor regulation.

Barr, who departed from his vice chair position earlier this year rather than face removal by the Trump administration but retained his position on the Fed board, has expressed his concerns regarding this. In a formal dissent, he cautioned that capital requirements are being significantly diminished, that liquidity requirements could also be lessened, that Federal Reserve supervisory staff have been reduced by over 30%, and that the banking sector is fundamentally based on trust.

This final statement warrants attention. A bank can endure deteriorating accounting until the moment the individuals whose funds are deposited within it cease to have faith in it.

Proponents of the broader revision present a reasonable argument. The original 2023 Basel proposal was widely perceived as overcalibrated, a blunt tool that shifts risk out of the regulated system into the shadows rather than genuinely mitigating it. Fed Governor Michelle Bowman stated that capital will remain strong and that the new framework now aligns better with requirements and actual risk.

However, the unrealized-loss carve-out persists even within the relaxed framework. If the issue were truly resolved, if duration risk and depositor confidence were no longer concerns for the market, there would be no justification for maintaining the provision. Regulators do not impose costly requirements out of sentimentality.

The inclination is to view the new proposal as straightforward deregulation. Yet, the more precise interpretation is also the more intriguing one. Even as Washington provides relief to banks, it is quietly retaining a crucial lesson from SVB: that when interest rates rise and losses accumulate, what a bank actually possesses remains significant, regardless of what the rules dictate.

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