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What America’s Recent Bank Failures Tell Us About ESG Phasing
Silicon Valley Bank’s obsession with sustainable financing and neglect for careful stewardship jeopardized its deposits, contributing to America’s historic bank run
By Stone Washington
Financial institutions that radically phase out fossil fuel and other politically scorned investments pose a serious risk to their own business, to investors and ultimately to America’s economy. This year alone, Silicon Valley Bank (SVB), Signature Bank and (more recently) First Republic all failed dramatically, while Silvergate voluntarily liquidated, and all were plagued by the same problematic strategy: an incorporation of environmental, social and governance (ESG) factors across their corporate governance. The zealousness of these banks to meet or supersede their stated ESG goals contributed to their inevitable collapse, since they pursued these goals at the expense of more important economic priorities.
How ESG Contributes to Bank Failure
Consider the epic failure of SVB earlier this year. It was the second-largest banking collapse in American history, its fall eclipsed only by that of Washington Mutual’s $307 billion in 2008, which occurred during one of the worst global financial calamities. Once the 14th-largest bank in the world, SVB managed $209 billion at its peak.
SVB’s executive team mismanaged the bank’s lending capacity, discounted fears of insolvency and refused to diversify its client base. But what made those problems much worse was the bank’s politically motivated overreliance on an ESG investing agenda.
Specifically, SVB and the other aforementioned banks pursued one particular method of ESG called “phasing.” ESG phasing combines two broad categories of ESG investing—exclusion and integration. First, the firm excludes or gradually replaces a formerly relied upon energy source—such as oil and gas—from an investment framework. Second, the firm integrates an untested renewable energy substitute into its mix of investments. Out with the old, in with the new.
SVB’s environmental investment strategies catered exclusively to transitioning to renewable fuel sources while prioritizing a precarious system of sustainable lending. This strategy is evident from SVB’s Task Force on Climate-Related Disclosures report, which states that “SVB does not lend to clients that extract, produce or generate electricity from fossil fuels and therefore has no exposure to carbon-related assets.”
All the while, bank executives did not provide prudent safeguards to retain deposits in the face of rising inflation. SVB relied mostly on holding government and government-backed securities to finance its sustainability projects. With the Fed’s repeated interest rate hikes, SVB’s Treasury bonds continued to lose value over time, diminishing the bank’s ability to retain deposits with enough cash in reserve. This left SVB powerless to make good on financing its net-zero-carbon initiatives and green-based lending. Those investments failed to produce any reasonable rate of return for deposits, as customers collectively withdrew their money years before the bank’s ESG agenda was ever realized. The bank was socked with billions of dollars of unrealized losses.
SVB Made Key Mistakes
Many of SVB’s financial failures could have been averted. First, SVB was not diversified enough. The bank extended its services exclusively to high-tech companies and high-net-worth depositors, with deposits averaging well above the $250,000 cap that the FDIC insures against financial failure. SVB provided loans to venture capitalists to finance projects for high-tech startups. At its height, SVB was the preferred funding choice for half of all venture-backed tech firms. This was SVB’s business model, owing much to its proximity to Silicon Valley, where half of the bank’s lending was in the private equity space.
ESG financing compounded that problem. According to its 2022 ESG report, SVB spent the past decade pursuing “sustainable innovation,” driven by the work of their Project Finance and Climate Technology & Sustainability teams. SVB sought to provide $5 billion in loans and investment capital by 2027 to businesses committed to advancing sustainable technologies through phasing. SVB executives fixated on sustainable lending goals rather than diversifying their customer base and extending their loan options.
By exclusively catering their services to risky venture capital startups, SVB exposed itself to a bank run when signs of its insolvency became apparent. SVB’s singular focus on sustainable financing projects exacerbated its inability to back depositors amid rising interest rates.
SVB also made a big mistake with its own investments. Mortgage-backed securities and Treasury bills were SVB’s key investments. SVB invested heavily in these bills probably because of the (false) belief that they were safe relative to nongovernment debt—that they were risk-free assets. Since SVB was not an ordinary bank, it did not use investment capital as prudently as traditional banks would. It instead invested money more heavily, in part to finance its bold sustainable lending projects. So, as high-net-worth customers invested with SVB, SVB simultaneously invested in the Treasury to help finance its own ESG agenda. The bank used a risky investment strategy to fund a riskier sustainability platform, and both gambles backfired.
As a consequence, SVB’s overdependence on U.S. Treasury bonds and ESG finance made it impossible to satisfy the demands of their customers’ startup ventures. The risks from financing unproven green technologies could not be counterbalanced by SVB’s equally risky dependence on “safe” U.S. Treasury bonds. In fact, SVB’s investments in ESG-aligned loans and mortgages alone often eclipsed the total managed assets and revenue that its individual branches generated.
For perspective, SVB’s most recent report reveals that total ESG spending was $9.1 billion greater than SVB Capital’s total managed assets and $15.8 billon greater than the total revenue collected by SVB Securities branch. Further, ESG spending was only $3.2 billion less than the total managed assets of SVB Private, the firm’s private banking and wealth management arm.
Promoting Sustainability, Denying Reality
Greg Becker, the former CEO of SVB, tried to deflect blame for the bank’s collapse. During his Senate testimony, Becker admitted to being caught unawares by Silvergate’s liquidation, which triggered a bank run for similar institutions such as SVB. Becker mostly blamed this crisis on social media hype, rather than acknowledging the mistakes of SVB executives.
To make matters worse, Becker claimed his team received mixed signals from financial regulators who alleged that inflation was merely “transitory.” However, as Senate Banking Committee Ranking Member Tim Scott (R-S.C.) and others noted at the hearing, the Federal Reserve consistently hiked interest rates in the months leading up to SVB’s collapse. “Ten interest rate hikes in about a year sends a signal of what is actually happening in the marketplace that seems to have been completely ignored by the bank execs,” Scott said.
Meanwhile, SVB’s Investment Banking arm made the situation even worse. It was tasked with facilitating financial development for venture capitalists, but SVB’s heavy focus on carbon neutrality ran contrary to the bank’s ability to generate enduring financial gains from its venture capital assets. This is because venture capitalists often rely on a variety of reliable securities when seeking to raise capital quickly for startups. Startups are generally funded through a diverse basket of stock options, but this strategy collided with SVB’s monolithic green-energy initiatives.
In SVB’s case, the primary goal for its venture capital clients was to provide fast money to startups with the expectation of accumulating rapid returns. Since SVB focused entirely on renewables, carbon neutrality and strict environmental finance goals, the bank failed to meet its clients’ expectations for rapid growth. As a result, SVB clients absorbed consistent losses on their investments over time. It’s telling that since 2017, no U.S. equity managers have relied exclusively on a net-zero-carbon investment approach.
A bank’s board of directors is supposed to guide the institution away from disaster. Yet SVB’s board of directors was instrumental in crafting the bank’s ESG structure, which was implemented by the CEO. The board maintained three ESG-related committees on “governance and corporate responsibility,” “compensation and human capital” and “regulatory disclosures.” The bank even managed an ESG Program Office and various working groups, all overseen by an ESG advisory committee that directed strategic operations for internal ESG program implementation.
Per its 2022 ESG report, SVB committed $5 billion in sustainable finance loans, $11.2 billion in socially responsible affordable housing projects and $18 million to charitable causes. This amounted to $16.4 billion in ESG-bundled investments, including sustainable phasing initiatives.
In addition to SVB’s internal mismanagement, financial regulators ignored repeated red flags. These warning signs included how most of SVB’s depositors were uninsured with the FDIC, how the bank lacked a stable cash reserve and how SVB depended too heavily on Treasury bonds that were rapidly devaluating because of rising interest rates. The Federal Reserve of San Francisco and the U.S. Treasury should have caught these signs early on.
Meanwhile, news media reporting made matters even worse. Fawning press in support of ESG investing may have legitimized its bad practices before regulators could take notice or action. Ironically, the ESG craze also become a significant part of its ticket to bailout, with many suggesting that the bank was rescued by the FDIC as an act of political favoritism by those sympathetic to its environmental agenda. Likewise, the Federal Reserve and the U.S. Treasury were caught completely unawares by the monumental financial collapses of ESG-friendly banks such as SVB and First Republic, despite their many red flags.
Financial regulators and federal auditors must not turn a blind eye to sketchy investment schemes in pursuit of transitioning to sustainable sources of energy. Regulators should instead prioritize investor trust. The absence of this trust imposes lasting financial damage upon taxpayers, who are left holding the bag from bank failure. The market volatility resulting from these bank failures will further undermine the worth of government subsidy programs.
ESG phasing is a real and present threat to the economy, deceptively submerged below the surface of ongoing financial disasters. Proponents of ESG ignore reality by disregarding the immense risks that come with transitioning to costly, untested renewables. SVB, Silvergate and Signature banks all expanded their environmental-themed investment products while simultaneously diminishing their fossil-fuel lending. But the banks pursued this strategy absent any corresponding shift in market demand. The institutional obsession over ESG phasing failed to align with the prevailing market circumstances of rising interest rates and growing unrest among depositors, spurring a mass exodus. To prevent another bank implosion of this magnitude, financial actors mustn’t ignore broader warning signs in the economy for the sake of satisfying a nonfinancial green agenda.