Elham Saeidinezhad
Barnard College, Columbia University; NYU Stern
December 2, 2024
The collapse of Silicon Valley Bank (SVB) provides a critical lens through which to analyze the evolving industrial organization of regional banks as they increasingly blend traditional deposit-taking functions with strategies typically associated with investment funds. This paper examines SVB’s adoption of private equity-style on-balance-sheet investments—such as venture capital credit lines and subscription facilities — alongside hedge-fund-like off-balance-sheet strategies, including swap spread arbitrage. These activities categorize SVB as a synthetic hedge fund, defined as institutions that replicate hedge fund performance using benchmarks like hedge fund indices. Synthetic hedge funds employ factor-based approaches and payoff distribution models to mirror hedge fund returns. While effective in certain market conditions, these models are fundamentally at odds with the operational priorities of deposit-taking institutions, which emphasize stability, liquidity, and depositor trust. SVB’s reliance on these models contributed to its premature exit from hedging strategies, driven by their inability to adjust to dynamic macroeconomic conditions. Misinterpreted economic signals amplified exposure to rising interest rates, highlighting the inherent risks of embedding hedge-fund-centric strategies within the liquidity-focused and stability-driven framework of traditional banking. This paper underscores the systemic implications of this shift in the industrial organization of banks and stresses the need for regulatory recalibrations. Enhanced derivatives-accounting transparency, tailored stress testing designed to reflect the realities of a new banking market structure, and scenario analyses that address the complexities of banking-synthetic hedge fund hybridity are essential to bridging the gap between financial innovation and regulatory efficiency. Furthermore, the paper considers the possibility that, in future banking crises, central banks may need to act as synthetic hedge funds of last resort to stabilize an increasingly complex and interconnected financial system.
The full paper is available at https://papers.ssrn.com/sol3/papers.cfm?abstract_id=5041554