Banking Crisis? Bank Collapse? The next financial crisis? Lehman Brothers?
What happened this couple of weeks?
A total of 3 banks in the United States have collapsed. This sent shockwaves across the entire financial industry and sparked fears about the country’s banking systems. Thus, we have seen red blood all over the US bank stocks.
Silvergate Bank, Silicon Valley Bank, and Signature Bank collapsed in recent weeks, leaving many people puzzled as to what went wrong. In this post, we will take a closer look at the banking crisis and investigate the causes behind their demise.
How did Silvergate Bank collapse?
Silvergate Bank is a San Diego-based bank founded in 1988. Silvergate invested heavily in mortgage-backed assets as well as US bonds. While these assets are guaranteed to be paid in full until their maturity date, they are subject to interest rate risk. This is because there is an inverse relationship between the mark-to-market value of a bond and its yield. Unfortunately, as the Fed starts to increase the interest rate to fight inflation. Silvergate got caught in the midst of it. Hence, the mark-to-market price of these assets fell dramatically as interest rates rose during the 2021-2023 inflation wave.
Following FTX’s bankruptcy, Silvergate had a bank run, with deposits from cryptocurrency-related companies plummeting by 68%, and the bank receiving requests from clients to withdraw up to $8 billion in deposits. Since Silvergate did not have enough cash on hand to cover the deposit withdrawals, the bank began selling assets at a loss; the business lost $718 million on withdrawal-related asset sales alone in the fourth fiscal quarter of 2022.
Faced with continuous losses from mark-to-market sales of securities, Silvergate issued a public notice on March 8, 2023, stating that the firm will go into voluntary liquidation and restore all deposited funds to their individual owners.
How did Silicon Valley Bank collapse?
Silicon Valley Bank is a California-based bank that specializes in financing technology startups and small companies. During the COVID-19 pandemic, when the tech industry was booming, Silicon Valley Bank grew its deposit holdings. To capitalize on the increasing deposits, it acquired long-term Treasury bonds in 2021. The present market value of these bonds, however, has plummeted as the Federal Reserve hiked interest rates in order to contain the 2021-2023 inflation rise. Moreover, rising interest rates also increased borrowing costs across the economy. Thus, some Silicon Valley Bank clients began withdrawing funds to fulfill their liquidity demands.
SVB reported on March 8 that it had sold approximately US$21 billion in assets, borrowed US$15 billion. Furthermore, they will undertake an emergency sale of part of its treasury shares to raise US$2.25 billion in order to cover depositor withdrawals. Customers withdrew cash totalling US$42 billion the next day, after the disclosure and warnings from key Silicon Valley investors.
As a result of the bank run, on March 10, 2023, the California Department of Financial Protection and Innovation (DFPI) seized SVB and placed it under the receivership of the Federal Deposit Insurance Corporation’s receivership (FDIC).
How did Signature Bank collapse?
Signature Bank is a Texas-based bank founded in 2004. Signature bank has a large number of cryptocurrency depositors during the boom of cryptocurrency in 2021. As cryptocurrency values plummeted considerably in 2022, Signature Bank cut connections with cryptocurrency exchange Binance in order to limit the bank’s exposure to cryptocurrency market risk.
On Friday, March 10, Signature Bank had a multibillion-dollar bank run, with depositors concerned about cryptocurrency-related dangers hurting the bank. Investor trust in the bank was also affected, and the bank’s shares fell 23% on that Friday—the day the Silicon Valley bank collapsed—marking their largest single-day drop in the Signature Bank’s value in its 22-year existence.
Signature Bank was closed by authorities from the New York State Department of Financial Services on March 12, 2023, two days after the collapse of Silicon Valley Bank, in what is the third-largest financial failure in US history.
How is the Fed helping?
In response to the March bank failures, the United States Federal Government took unprecedented steps to limit the damage throughout the financial system. On March 12, the Federal Reserve (Fed) established the Bank Term Funding Program (BTFP), an emergency lending program that provides banks with loans of up to one year in length.
Moreover, the Fed loosened conditions at its discount window. For additional backup of the program, the Treasury Department will make available up to $25 billion from its Exchange Stabilization Fund.
In addition to collaborating with the FDIC and the US Treasury to provide liquidity to banks through the BTFP, the Fed has begun to internally discuss implementing stricter capital reserve and liquidity requirements for banks with balance sheets containing $100 billion to $250 billion in assets.
Our Thoughts
The failure of these three banks serves as a reminder to everyone out there, the value of diversification and capital reserves. Banks should constantly aim to diversify their loan portfolios and keep adequate capital reserves on hand to safeguard themselves from such economic downturns. The Fed is doing its part to assist the financial sector, but it is ultimately up to the banks to ensure proper risk management.
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