Posted by Chip Hunt | March 15, 2023
By Chip Hunt
Banks play a vital role in the economy, providing individuals and businesses with access to cash, credit, and other financial services. Despite their importance, however, banks can fail. And when they do, the effects often cause panic in the wider economic environment.
This past week, two major players in the banking industry, Silicon Valley Bank and Signature Bank, collapsed after they had trouble raising capital to meet the demand for the withdrawal of depositors’ funds. While there are several reasons why experts believe these failures are not part of a more significant economic crisis, everyday investors are still understandably worried. These were the second and third largest bank failures in U.S. history, behind only the collapse of Washington Mutual in 2008.
Thankfully, there are safeguards in place that make it highly unlikely that clients will lose their entire life savings, even in the event of widespread banking failures. In this article, we explore why banks fail, what insurance protections are in place, and the safety of your savings.
Why Do Banks Fail?
Banks can fail for several reasons, including undercapitalization, liquidity issues, safety and soundness concerns, and fraud.
- Undercapitalization occurs when a bank has insufficient capital reserves to cover ordinary business expenses or meet regulatory requirements, which leaves it vulnerable to financial shocks. For instance, a bank that has issues generating cash flow or accessing financing in the form of debt or equity may find itself undercapitalized.
- Liquidity issues arise when a bank lacks sufficient cash or liquid assets to meet its obligations, which can happen when a large number of depositors withdraw their funds all at once.
- Safety and soundness concerns occur when a bank engages in risky lending practices, such as offering subprime loans or investing in volatile assets. This was a big issue during the 2008 financial crisis when several major banks failed due to their investments in subprime mortgages.
- Fraudulent activities, such as embezzlement or insider trading, can cause significant financial losses for a bank and erode depositor confidence.
Banks that fail to manage these risks effectively may become insolvent and ultimately fail, jeopardizing the stability of the financial system and the broader economy.
What Happened With SVB & Signature?
SVB and Signature Bank both failed due to liquidity issues stemming from what’s known as a bank run. A bank run occurs when a large number of depositors withdraw their funds from a bank over a very short period of time (usually days). Because banks invest the cash deposited with them, a high demand for withdrawals can force the banks to sell off investments at a poor market price in order to meet the liquidity need. Consistently selling assets at a substantial loss can exacerbate liquidity issues and quickly cause a bank to become insolvent.
Silicon Valley Bank almost exclusively served tech start-ups and venture capital-backed clients, which were particularly hard-hit during the economic volatility of 2022. As financing started to dry up for tech companies and venture capitalists couldn’t come up with additional funding, clients began withdrawing funds from their accounts at SVB to meet the operating expenses for their businesses. SVB was forced to sell billions of dollars’ worth of long-term Treasury bonds (initially bought when rates were near zero) at a massive loss to raise capital. This spooked other depositors, many of whom had accounts well above the FDIC-insured limits, and caused them to withdraw their money at an unsustainable rate. SVB could not meet their deposit requests and attempts to raise capital or sell the assets to a healthier bank were unsuccessful. The FDIC quickly stepped in as receiver and took over operations to prevent further damage.
A similar story unfolded at Signature Bank, which served mostly crypto investors. Similar to the depositors at SVB, many of the accounts held at Signature Bank were well above the FDIC-insured limits. Spooked by the failure of SVB, depositors at Signature Bank withdrew over $10 billion on Friday, March 10th. By Sunday, March 12th, the bank was taken over by the FDIC to protect the stability of the U.S. banking system.
What to Expect From Other Banks
While the effects of the SVB and Signature Bank failures are hard to predict, the FDIC has reacted swiftly to prevent further damage. Regulators have invoked a “systemic risk exception” which allows the government to reimburse uninsured depositors. The Fed has also set up an emergency lending program to provide funding to eligible banks at risk of bank runs.
Shares of regional bank stocks took a beating on Monday, March 13th, as investors tried to process the news of SVB and Signature Bank. First Republic Bank was down over 60%. Larger banks, including Wells Fargo, Bank of America, and JPMorgan were less affected, falling just 7%, 3%, and 1%, respectively. On Tuesday, (at the time of this writing) investor optimism that government regulators had taken effective action to stem the contagion to other regional banks sparked a rally in bank stocks and the broader markets.
For what it is worth, we fall into the camp with those who believe these particular banks took on special risks that were unique to their respective organizations and are not representative of the overall banking system and that system-wide contagion is unlikely. In the meantime, I expect we will continue to see volatility in the markets with recurring ebbs and flows between investor sentiment and regulatory safety initiatives. This too will pass.
Finding the Silver Lining
The events of this week will likely cause the Federal Reserve to re-think the degree to which they want to raise rates next week in their continuing battle against inflation. Just last week, Chairman Powell took an aggressive tone, causing many to speculate that the Fed’s might raise rates another 0.50%… and the markets responded negatively. But this week, we have reports that inflation numbers cooled down to a 6% rate in February (down from a 6.4% in January) coupled with the highly publicized news of these bank failures. This week’s events may well cause the Feds to back down from another sharp rate hike.
Unemployment still remains low, and while these events may have a dampening effect upon the U.S. economy as credit tightens up on smaller businesses, there is still a resilience to the economy. To quote a respected economist’s comment that I heard on Monday, “we may be on the edge of a swamp… but certainly not a cliff”.
Our advice would be to not get caught up in the “crisis”. Getting “out” when one is frightened by the “crisis” and getting back “in” when one gets comfortable, sounds an awful lot like selling low and buying high to me. Those are two decisions that are just extremely difficult to get right. And in the meantime, you whipsaw yourself.
How We Can Help
If you’re worried about the recent bank failures and you have questions and want to talk to someone about how they might impact your finances, don’t hesitate to reach out to us for guidance. Our team can help you understand your options and develop a plan to protect your assets, minimize your risk, and provide counsel on FDIC and SIPC insurance coverage. If you have questions or would like some more information, please get in touch with us today!
Chip Hunt is the founder and President of PrimeTRUST Advisors, an investment advisory firm dedicated to helping individuals and institutions with their retirement plan. His desire to embrace the true fiduciary role (working for the best interest of others) motivated him to launch the firm in 2006 to transform this belief into a reality.
Chip graduated from the University of the South (Sewanee, TN) with a BA in English. He credits his “formal” education to his 40 years in the financial services industry, most of which were spent growing up as the 3rd generation in his family’s actuarial services firm managing corporate pensions, 401(k)s, and designing investment structures within those plans. Chip serves in leadership roles in retirement industry organizations and is an author and frequent speaker on retirement topics. Mostly though, Chip loves working “in the trenches” alongside his clients, seeking to serve their needs in this specialty field.
Chip loves the outdoors! He’s been known to sneak out of the office “due to weather conditions” and hit the Swamp Rabbit Trail on his bike. Either that, or you’re likely to find him on a near-by hiking trail.
Fun Fact: At Sewanee, Chip served 4 years on the student-led, community fire department as the chief-engineer (the driver of the firetruck).
To learn more about Chip, connect with him on LinkedIn.