This is a reasonable concern many investors raised in the wake of three bank failures in March. Worries led investors to reduce deposits, but the larger fear was whether banking could be entering a larger financial crisis.
First, it’s important to know deposits at an FDIC insured bank are completely insured by the federal government up to $250,000. In the same way, SIPC protects investors against the loss of cash and securities – such as stocks and bonds in client brokerage accounts (up to $500,000, which includes a $250,000 limit for cash).
And note when those three banks failed, the U.S. government even guaranteed deposits that exceeded FDIC levels. All deposits were guaranteed. Those are basic protections in place, but to address the larger concern, a repeat of the 2008 financial crisis is highly unlikely. Leading up to the crisis in 2008-09, most banks were highly leveraged. What’s worse, those overly leveraged banks were invested in mortgage-backed securities, many of which defaulted.
Today bank balance sheets are much less leveraged, and most assets are in high quality Treasuries and guaranteed agency securities. The failures of Silicon Valley Bank, Signature Bank and Silvergate Bank were due in part to the Federal Reserve’s aggressive campaign over the last 12 months to combat inflation by raising interest rates. These increases led to an increase in borrowing costs for banks. Essentially the rising rates exposed a couple banks that were most vulnerable.
This suggests the problem is not systemic across the whole banking industry but more an issue for the individual banks. For instance, Silicon Valley Bank became vulnerable to rising interest rates because of the high concentration of deposits held by privately held tech companies and startups. Much of the bank’s large bond portfolio was invested before the increase in interest rates.
These banks failed not because of lack of solvency but a lack of liquidity. Generally, assets in the failed banks were high quality. The problem came when many depositors made significant withdrawals, these banks had sell their own investments at a loss to cover withdrawals. Those losses eroded capital ratios, which required them to raise even more capital. Then posts on social media announced these banks had to raise capital, which caused more depositors to withdraw, and the escalating cycle resulted in the bank failures. In response, the Federal Reserve and the Treasury Department created new lending programs to shore up regional banks and prevent bank runs. Essentially this allows banks to borrow the money they need to cover withdrawals by putting U.S. Treasury and agency bonds up as collateral at par value. This means banks avoid the losses that erode capital ratios and interrupts the negative cycle.
Fed chairman Jerome Powell announced at a March 22 news conference: “We took powerful actions with Treasury and the FDIC, which demonstrate that all depositors’ savings are safe. The banking system is safe. Deposit flows in the banking system have stabilized over the last week….
We have the tools to protect depositors when there’s a threat of serious harm to the economy, or to the financial system. And we’re prepared to use those tools. And I think depositors should assume that their deposits are safe and secure.”
Thankfully, at this point things appear to have calmed.
There are important differences between what happened this past March and the crisis back in 2007-08. The hope is that these issues were with particular banks rather than across the whole banking industry and that they have been contained.