The Banking Crisis and You
This is Part 2 of an article on the recent banking crisis in the U.S. Part 1 (What Caused the “Run on the Bank?”) can be found here.
How Do Banks Invest Our Deposits?
Silicon Valley Bank reportedly had deposits that totaled $173 billion. Withdrawals on March 9 were $42 billion and attempted withdrawals on March 10 were $100 billion. This totals $142 billion, so can we assume the bank could have processed the March 10 withdrawals, with a whopping $31 billion remaining? This would have been true if the bank kept all of the deposits in cash. Of course, that is not the reality of how banks work. Below is a diagram that shows how banks invest the deposits they receive from their customers.
Banks hold very little cash. On March 26, 2020 the Federal Reserve eliminated requirements for cash reserves for banks. They invest the majority of the deposits because they need to earn money to pay their customers, who are now demanding higher returns on savings accounts and Certificates of Deposits (CDs) due to the Federal Reserve raising short-term interest rates. Banks invest a portion of their reserves in bonds, and they also provide loans to customers for home mortgages, car purchases, lines of credit, commercial real estate, and small businesses. They may also invest in community projects, such as housing and business development.
In addition to holding very little cash, the vast majority of their investments are not liquid. How quickly can a bank liquidate a 15-year or 30-year fixed-rate jumbo mortgage? This is the reason a “run on the bank” is so dangerous. When customers want to withdraw their deposits quickly, banks panic.
Banks have access to cash loans in an emergency, and upper management at Silicon Valley Bank was working frantically on Thursday, March 9, to try to secure a large cash infusion due to the unexpected run on the bank. The Wall Street Journal reported that SVB first attempted to secure a $20 billion loan from the San Francisco Federal Home Loan Bank. The processing time became a problem, so they looked at accessing the Federal Reserve’s discount window. When that didn’t work, they contacted the Bank of New York Mellon Corp., but they missed the cut-off time at the bank. Customers withdrew $42 billion from Silicon Valley Bank on Thursday, leaving the bank with a negative cash balance of approximately $1 billion. On Friday morning they were working to process the cash infusions mentioned above, but customers were attempting to withdraw $100 billion. The FDIC stepped in Friday afternoon and took over the bank.
The situation at Signature Bank was very similar to Silicon Valley Bank, except it had the added risk that roughly 20% of its deposits were from customers in the crypto industry. The FDIC stepped in quickly (on March 10 for Silicon Valley Bank and March 12 for Signature Bank) to take over the banks.
On Sunday, March 12, 2023 an announcement was made that a “systemic risk exception” would be used to insure all of the deposits for both banks, regardless of the amount over the standard FDIC limits. This announcement was made by a coalition that included the FDIC, Treasury Department, Federal Reserve, and President Biden. The FDIC estimated the expense of insuring all deposits at Silicon Valley Bank at $20 billion, and Signature Bank cost the FDIC $2.5 billion.
Tomorrow’s post will be “What Dangers are Lurking Below the Surface? Will There be More Bank Failures?”