Has something finally broken the financial system?

^{Written by: Benjamin Bimson CIMA®, CMT® / CIO, Trek Financial}

After the Federal Reserve bank hiked interest rates over 4.75% in roughly a year, the banking industry has shown signs of challenges. Silicon Valley Bank (SVB) was seized by the Federal Deposit Insurance Corporation (FDIC) on Friday, March 10^th. Two days later, Signature Bank was shut down by regulators.

Since that time, news agencies have reported on other banks that have struggled with the economic environment created by rapidly increased interest rates and depositor anxiety. There is no shortage of opinions in the news outlets and a few wake-up calls to depositors as well. After all, these two banks represent the 2^nd and 3^rd largest banks to ever fail in the United States.^1,2

A look at how it happened

It is important to understand what happened at the two banks that led to their downfall. SVB and Signature Bank had clientele that consisted primarily of technology companies, private equity firms, and cryptocurrencies. These customers also had significant deposits above the FDIC insurance limits. In the case of SVB, more than 90% of deposits were above the insurance limits. ³ Second, the types of companies that used these banks are businesses that are sensitive to rising interest rates and therefore needed to make significant withdraws over the past year to meet obligations. They had built up large cash positions during the COVID crisis and therefore had cash to withdraw. Banks typically purchase treasuries, mortgage back securities, and other approved investments to secure bank deposits. Those investments are also interest rate sensitive. As a result, the banks needed to sell bonds at a loss to offset the withdraws.

After SVB announced a large portfolio loss on March 8^th, one of the influential venture capital fund managers recommended portfolio companies withdraw deposits from SVB, which may have sparked the bank run that ultimately led to the failure of the bank.⁴ Bank runs are extremely rare and this one was at a particularly susceptible bank. Signature bank had a similar exposure as SVB and was seized by regulators before markets reopened on March 13^th out of fear of contagion. The depositors were fully backed by FDIC as an extraordinary measure.

In the US and around the world, the banking systems are vast. To make matters more complicated, not all banks are the same. There are small community banks, medium-sized regional banks, and large banking institutions and conglomerates. To some extent, they work the same way. In other ways they are very different. Smaller banks tend to be more specialized and potentially have more homogeneous clientele. If that client-base suffers at the same time as bank stress, trouble is a possibility.

The FDIC exists “to maintain stability and public confidence in the nation’s financial system.”⁵ It is an independent agency of the federal government, created in 1933 in response to the thousands of bank failures that occurred in the 1920s and 1930s. This is the insurance guarantee program that member banks all pay premiums into in order to secure a limited portion of depositor funds. Today the standard insurance is $250,000 per depositor, per insured bank, for each account ownership category.  

There are different regulatory requirements for banks of different sizes. Therefore, small banks have less regulation than banks that are deemed Globally Systemically Important Banks (G-SIBs). In addition to giant banks, there are other large banks deemed domestically systematically important banks. Collectively, these banks are often referred to as “too big to fail.” The implication is that due to the global financial crisis of 2008, there is little appetite to allow any of these banking institutions to fail. Credit Suisse is a recent example of what happens when a G-SIB bank begins to have financial pressures. Extraordinary efforts are made to support the bank. In this example, the Swiss National bank and UBS coordinated a sale of Credit Suisse to UBS. ^6,7

With all of the recent bank stress and concern in the market, the Federal Reserve hiked rates again on March 22^nd and noted the bank situation in their press release.⁸ Notable is the likeliness of credit conditions to tighten globally as a result of the banking stress. However, the Fed remained steadfast in their commitment to bring inflation down.

Should we be concerned?

Anxiety is understandable in a very complex financial landscape amidst uncertainty. It can be helpful to understand how this current stress compares to past stressors that regulators and policy makers have navigated. Here is a chart showing how the current global stress compares since 2007.