Home Business After the collapse of SVB, Why people are afraid of banks

After the collapse of SVB, Why people are afraid of banks

by SuperiorInvest

Banks balance how customers tear their deposits. Markets swing as investors rush to safety. Regulators are dragging their feet after years of complacency.

Fifteen years ago, the world plunged into a devastating financial crisis, precipitated by the collapse of the US housing market. Today, the financial system highlights another culprit: rapidly rising interest rates.

The sudden collapse of Silicon Valley Bank and Signature Bank — the the biggest bank failures since the Great Recession — have greatly eased lender uncertainty. First Republic Bank was forced to seek a lifeline this week and received tens of billions of dollars from other banks. And concerns about the stability of the banking system have hit Credit Suisse, the battered European giant.

But the storm had been quietly building for months.

The awfulness of some banks can be traced to how they fundamentally operate.

The simplest way to think about a bank is that it takes deposits from customers and lends those funds to people who want to buy a house or to companies hoping to build a factory. However, the reality is more complicated.

Diagram of a hypothetical bank experiencing a run.

A hypothetical bank. . .

Accepts 2 billion dollars in

deposits from their customers.

He then invests this money:

1 billion dollars in loans it gives

out; 1 billion dollars in bonds.

When interest

rates rise,

newer bonds

pay more.

Older bonds are less attractive

to buyers and become less valuable:

The bonds the bank has are now

value 500 million dollars.

The bank now has only 1.5 billion dollars in

assets – much smaller than what they were

originally saved. If there are enough customers

ask for a refund, the bank can

not all funds can be returned.

The more people notice, the better

they demand more for their money

back, creating a run to the bank.

That’s what happened with the Silicon Valley bank that was seized by regulators on March 10 and that investors immediately saw as a possible harbinger of similar problems at other banks.

The problem with SVB was that it held many bonds that were bought back when interest rates were low. Over the past year, The Federal Reserve raised interest rates eight times in the fight against the highest inflation in several generations. As rates rose, newer versions of the bonds became more valuable to investors than those held by SVB.

As the tech industry cooled, some SVB customers began withdrawing their money. To raise cash to pay depositors, SVB sold $21 billion worth of bonds. The bank suffered a loss of nearly $2 billion.

The losses raised alarm among investors and some of the bank’s customers. If the rest of SVB’s balance sheet were studded with similar money-generating assets, would the bank be able to come up with enough money to pay off its depositors?

Instead of waiting to find out, customers rushed to withdraw their funds – tens of billions of dollars.

A classic bank run was underway.

“With the Fed carrying out its most aggressive monetary tightening in 40 years, it seemed only a matter of time before something broke,” analysts at Macquarie Securities wrote on Friday.

Even before the SVB coup, investors were competing to see which other banks might be susceptible to similar spirals. One clear red flag: big losses in the bank’s bond portfolios. These losses are known as unrealized losses – they only turn into real losses if the banks have to sell the assets.

Since the Fed started raising interest rates, banks have been facing mounting unrealized losses.

These unrealized losses are particularly notable as a percentage of a bank’s deposits — a key metric because larger losses mean a greater chance that a bank will have trouble repaying its customers.

Unrealized gains and losses

on each bank’s investment securities as a share of its deposits

A series of bar charts showing unrealized gains and losses on investment securities as a share of deposits for six mid-sized banks from 2019 to 2022: First Republic, Pacific Western, Signature, Silicon Valley, Western Alliance and Zions. In every quarter of 2022, all banks had unrealized losses.

Source: Federal Financial Institutions Examination Council

Note: Includes both “held-to-maturity” and “for-sale” securities, meaning both long-term and short-term investments.

U.S. banks faced more than $600 billion in unrealized losses from rising rates at the end of last year, federal regulators say estimated.

Those losses had the potential to eat through more than one-third of banks’ so-called capital buffers, which are supposed to protect depositors from losses, according to Fitch Ratings. The thinner a bank’s capital reserves, the greater the risk that its customers will lose money, and the more likely investors and customers will flee.

But the $600 billion figure, which represented a limited pool of bank assets, could understate the severity of the industry’s potential losses. Just this week, two separate groups of academics released paperwith estimates that banks face potential losses of at least $1.7 trillion.

The most shy bank customers tend to be those whose deposits are not insured.

This was a huge problem at SVB, where more than 90 percent of deposits exceeded the amounts covered by federal insurance. The Federal Deposit Insurance Corporation insures individual account deposits up to $250,000, and many other banks also have increased levels.

Top 50 banks by share of deposits that are not FDIC insured

It does not include banking giants considered systemically important

Bar chart showing the share of deposits that were not federally insured at 50 U.S. banks as of the end of last year. At both Silicon Valley Bank and Signature Bank, more than 90 percent of deposits were uninsured.

Larger share of uninsured deposits

94% of the total $161 billion in deposits

The height of the columns is proportional to the total domestic deposits of each bank

Larger share of uninsured deposits

94% of the total $161 billion in deposits

The height of the columns is proportional to the total domestic deposits of each bank

Sources: Federal Financial Institutions Examination Council; Financial Stability Board

Notes: Data is as of December 31, 2022. Includes domestic deposits only. Does not include global systemically important bankswhich are subject to stricter regulations, including stricter capital requirements.

To make matters worse, many banks — especially those with $50 billion to $250 billion in assets — kept less than 4 percent of their assets in cash, according to Fitch.

Banks with less cash on hand may be more likely to incur losses if there is a rush of withdrawals.

Six bar charts showing the total amount of cash and non-cash assets held by mid-sized banks from 2019 to 2022: First Republic, Pacific Western, Signature, Silicon Valley, Western Alliance, and Zions. Even as their assets rose, these banks held only a small proportion of cash.

Cash and non-cash assets of banks

Cash and non-cash assets of banks

Source: Federal Financial Institutions Examination Council

Medium-sized banks like SVB not have the same regulatory oversight as the largest national banks, which, among other provisions, are subject to stricter requirements to hold a certain amount of reserves in times of crisis.

However, no bank is completely immune to the rune.

“I don’t think anyone can withstand 25 percent of their deposits leaving in a day, which is what happened” in the case of SVB, said Nathan Stovall, banking analyst at S&P Global Market Intelligence.

The Federal Reserve and other regulators are rushing to reassure everyone. Last weekend, the Fed announced the program which offers loans up to one year to banks using the banks’ government bonds and some other assets as collateral.

Crucially, the Fed said it would value the bonds at their original value — not the lower levels that banks could get if they tried to sell them quickly in the markets. The Fed’s goal was to send a reassuring signal that banks would not have to transform unrealized potential losses into crippling real ones.

So far, at least, this program hasn’t changed the game much. Banks borrowed only about $12 billion—a tiny fraction of the deposits that were withdrawn from SVB itself before its implosion.

However, banks swallowed a whopping $153 billion in loans through the Fed’s traditional lending program. That was less than $5 billion a week earlier and was the largest amount borrowed in a week since the 2008 financial crisis.

The panic that started at SVB continued to spread to other banks.

Swiss authorities vowed on Wednesday to protect bank giant Credit Suisse as concerns swirled about its stability. The next day, US authorities helped orchestrate an industrial bailout of the First Republic – one of the big banks that was attracting particular attention from jittery investors.

Problems lurking in the balance sheets of small banks could have great impact on the economy. Banks could change their lending standards to support their finances, making it harder for a person to get a mortgage or a business to get a loan to expand.

Goldman analysts believe it will have the same impact as a Fed rate hike of up to half a point. Economists have debated whether the Fed should hold off on raising rates amid the financial turmoil, and futures markets suggest many traders believe it could begin cutting rates before the end of the year.

Investors on Friday he continued pounding shares of regional bank shares. Shares of First Republic have fallen more than 80 percent for the year, and other regional banks such as Pacific Western and Western Alliance have lost more than half their values.

In other words, investors are far from convinced that the crisis is over.

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