As you may have heard, a recent spate of bank closures has rattled the financial sector and the markets. The closing of Silverlake Bank on Thursday March 9, 2023, Silicon Valley Bank (SVB) on Friday March 10, 2023, and Signature Bank on Sunday, March 12, 2023, has raised a host of questions regarding the US banking system.
Is the money I deposited in my local or on-line financial institution safe?
The answer is YES. Unlike 2008, this is not a financial system-wide issue. These banks catered to a certain clientele. FDIC Insurance is still well funded. The Federal Reserve has established a special temporary lending program, put in place to advance funds for up to one year to any federally insured bank that is eligible to borrow from the central bank. The goal is to allow banks to cover deposit outflows without having to absorb loss on depreciated securities, according to Goldman Sachs analysts.1 In fact, you may have already heard from your bank about this situation and their response to it.
How did this happen?
- The business of any bank is to gather deposits, make loans, and make a profit. One part of banks’ profits comes from “spread” – the difference between the interest rate a bank pays its depositors, and what it charges to loan customers.
- Another way banks earn profits is through investment activity. The money you deposit into your bank is not sitting on a vault shelf somewhere, a portion of it is used to fund loans to other customers, a portion of it is kept on hand to meet withdrawal requests, and a portion of it is allowed by law to be invested in very safe Treasury securities, including bonds.
- As we’ve all experienced, rising inflation has prompted the Federal Reserve to raise interest rates. The effect that rising interest rates has on bonds is this: as interest rates rise, bond prices fall. For example, the 7 year Treasury Bond you bought for $10,000 in 2019 is today still paying you the same $238.90 annually, but if you tried to sell that bond out in the market today, you would get less than $10,000 for it. Why? Because I can go out today and buy a new 10 year Treasury for $10,000 and earn $364.50 annually. (as of 3/13/2023)
- As these banks’ clients needed extra money and stressed earnings reports were published, “runs on the bank” occurred. At similar financial institutions depositors demanded their cash, those demands being fueled by social media commentary.
What makes these banks different from most other financial institutions?
- All three of these banks catered mostly to ultra-high net worth clients or businesses that held deposit balances over the FDIC insurance $250,000 threshold.
- They all catered to businesses and individuals involved in the technology (including cryptocurrency) sector, which has experienced significant market stress lately.
- Their difficulties significantly stem from Federal Reserve interest rate increases. As companies strive to grow (as most technology companies do), they rely heavily on borrowed funds, and as those funds get more and more expensive to obtain, that puts pressure on those companies’ bottom lines.
- And as those companies try to use more cash instead of borrowing, these three banks had trouble meeting their customers’ requests for cash. To a great extent that is because the bonds they held as investments were losing value (see explanation below). When they needed to sell those bonds to meet customer cash demands, they were not able to sell them at the prices they needed in order to be able to meet the cash demands of their customers.
As a taxpayer, am I on the hook for this situation?
- NO. These banks were all insured by the Federal Deposit Insurance Corporation (FDIC). FDIC Insurance is funded by covered banks. Customers of FDIC insured banks are covered by $250,000 in deposit insurance per account registration. Even though most of the customers affected by these three closures had deposits over that amount, the FDIC has promised to make every depositor “whole” and cover all deposits held at SVB and Signature Bank. The FDIC has enough resources to take care of this situation as it currently exists. There is no need for any “taxpayer bailout”. The Federal Reserve, working hand-in-hand with the FDIC, has also now established a short-term lending program for use by other financial institutions that find themselves subject to out-sized cash withdrawal requests. However, shareholders and unsecured creditors at SVB and Signature will lose their money and bank executives will lose their jobs.
While these times are challenging, I am confident that the plans we put in place together will weather these current financial conditions. If you would like to talk further about the changing market or your own changing circumstances, please email or call me to review your portfolio. Email: email@example.com; Phone: 215-272-6431
1CBS News, Alan Sherter, 3/13/2023