The Banking Crisis and You
Why should you care about the collapse of Silicon Valley Bank and Signature Bank? They occurred several months ago, and you were probably not directly impacted.
Because many banks in the U.S. are still in danger of failing.
A few weeks ago, I was asked to speak about the recent banking crisis for a group in Albuquerque. I accepted the challenge, and took a deep dive into information involving the collapse of Silicon Valley Bank, Signature Bank, and First Republic Bank. Although there were many factors involved in the bank failures, I focused on four:
- What Caused the “Run on the Bank?”
- How do Banks Invest our Deposits?
- What Dangers are Lurking Below the Surface?
- How Can you Protect Yourself from Future Bank Failures?
This article is too long for LinkedIn, so I am dividing it into 4 posts. Today is Part 1. I will post one each day, and they will include links to the prior posts.
What Caused the “Run on the Bank?”
Regulators were not expecting a “run on the bank”, which was eerily similar to the events of the 1930s during the Great Depression. Although there were bank failures during the 2008 financial crisis, they were very different than what occurred at Silicon Valley Bank (SVB) on March 10, 2023. SVB’s target market was the technology industry and start-ups, and 94% of the deposits were over the FDIC limits for insurance.
Twitter spread the word rapidly that SVB was in financial peril, and technology advancements in recent years allowed customers to use online banking and smartphone apps to move their accounts instantaneously while sitting at home in their pajamas. And they did. Customers knew their account balance exceeded the FDIC limits, and fear of losing their money was a major factor in their impulsive behavior. A wait-and-see attitude did not seem prudent.
On Thursday, March 9, 2023, $42 billion was transferred away from SVB, and on Friday, March 10, customers were attempting to move an additional $100 billion. Total deposits were reportedly $173 billion.
A major factor in the bank’s financial troubles was the increase in interest rates by the Federal Reserve that began in March 2022. In slightly over a year, the Federal Reserve raised short-term interest rates from zero to five percent, in its effort to reduce inflation. Federal Reserve Chairman Jerome Powell’s stance during 2021 that inflation was “transitory” turned out to be inaccurate, and the interest rate increases have been swift.
Higher interest rates have negatively impacted many sectors of the economy, and—prior to the bank failures—the impact on the financial statements of banks did not receive sufficient attention from regulators.
The technology industry (which was a large part of the customer-base of SVB) grew rapidly during 2021, and bank deposits at SVB tripled in only three years. This created a challenge for the bank’s executives to determine how to invest the new money (reserves). They chose to invest significant amounts in long-term treasury notes and mortgage-backed securities in 2021 and early 2022. These were considered safe, and the bank was attempting to earn a higher yield than if they had limited their purchases to short or intermediate-term fixed income investments.
If the Federal Reserve did not raise interest rates, holding much of the bank’s reserves in long-term bonds would not have been a problem. However, as interest rates increased (March 2022 – May 2023), the current market value of the bonds decreased significantly. This caused what is termed “unrealized losses,” which result from the discrepancy between the maturity value of the long-term bonds (shown on the bank’s financial statements) and the current market value. If the bank could hold the bonds until maturity, then the current (lower) market value would be irrelevant. However, if a large number of customers decided to withdraw their money, then the bonds would have to be sold early, triggering the losses.
The unrealized losses in the bank’s reserves were on the radar screen of regulators, but they severely underestimated the risk. In an article dated November 11, 2022 Jonathan Weil of the Wall Street Journal reported that the market value of bonds held by 24 large US lenders in the KBW Bank Index were 14% lower than the maturity value, and some banks had losses as high as 18%. By early 2023, the losses were even larger.
The Federal Reserve released an extensive report on the failure of SVB on April 28, 2023, blaming the collapse on mismanagement by bank executives, and lax oversight by Federal Reserve regulators. Greg Becker, CEO of SVB, blamed the bank’s collapse on the rapid increase in interest rates by the Federal Reserve.
Both are correct, but the biggest culprit in my view was the fear-induced, run on the bank that led customers to move their accounts so rapidly that regulators or government officials could not slow the momentum or prevent the bank failures. This has repercussions throughout the entire banking industry, indicating that banks no longer have a “sticky” relationship with their customers. The loyalty that banks relied on from their customers over many decades has disappeared.
Tomorrow’s post will cover: How Do Banks Invest Our Deposits? (Hint: Our deposits are NOT in cash in the bank’s vault!)