More than $23 trillion are held by banks in the
United States, with 94% of adults owning some
form of bank account.
Banks are critical to the American economy.
Credit is the lifeblood of the economy.
Banks are like the heart of our economy that pump
credit, the blood, throughout the financial
system.
They bring lenders together with corporates,
individuals who need financing, the deposits
that they hold for institutional and retail
clients. They help fund the economy.
They help make the economy grow.
But like any other institutions, banks are
capable of failing.
Over 550 banks have collapsed since 2001,
according to the FDIC.
The first year in American history where
not a single bank failed was 2005.
Before 2005, at least one bank had failed in
every year in American history.
It's cyclical. We have periods of time where the
economy is doing well, things are stable, and we
have years where there are no failures at all.
And then we have other episodes where we go
through recession or some kind of financial
stress and failures spike.
The collapse of Silicon Valley Bank, Signature
Bank, and Credit Suisse were a harsh reminder of
how quickly a trusted institution could fail,
putting billions of dollars at risk.
It's the largest bank meltdown since the Great
Recession more than a decade ago.
So what exactly causes a bank to fail?
And what implications does it have on the US
economy? There are three main risk factors that
can push banks into the risk of collapse.
They have credit risk. When they make loans,
institutions and the individuals they're
making loans to, they're exposed to defaults on
those loans. So banks carry credit risk.
Secondly, they have interest rate risk.
They have assets that have a particular
interest rate risk profile. They have
liabilities. And one of the jobs of a bank is to
match the interest rate profile of assets and
liabilities and to try to minimize that interest
rate risk. And they have liquidity risk as well.
Bank failures become a possibility when these
risk factors impact either the bank's
liquidity or solvency.
Solvency refers to a bank's ability to meet
its long term financial obligations and debt,
meaning the bank's total asset is capable of
covering its liabilities.
In terms of solvency, this is generally when
banks have a lot of loans go bad.
The way that banks make money is that they bring
deposits in and then they lend that money out
on the premise that they're going to collect
those loans back.
And they collect those loans back with a little
bit of interest. They pay some of that interest
to the depositors and they keep the rest.
Well, if banks have loans that go bad, that's
money that's not coming back into the bank.
And if you have enough of those go bad, it can
cause the bank to fail where there's not enough
money coming in to pay those depositors that
they've gotten the money from.
Many of the banks failed due to insolvency during
the 2008 recession, including Washington
Mutual, the largest bank to collapse in American
history.
If you recall back in the aughts, a lot of people
were getting adjustable rate mortgages and they
were getting mortgages that were often referred
to as NINJA loans or NINJA mortgages, which
was no income, no job, no assets.
They would get people into a mortgage with a
very low teaser rate, maybe half the rate of
what you would actually pay. But after six months
or a year or two years, then the rate would
adjust to market rates.
Well, if you're barely able to afford that
mortgage at the teaser rate, that introductory
rate they gave you, once those rates jumped,
people couldn't afford those mortgages anymore
and they began to default on those
mortgages. And so Washington Mutual had a
lot of these. And so you saw this with a lot of
banks in that 2008, 2009, 2010 time frame.
Liquidity refers to how much money banks have to
meet their short term financial obligations.
When you put your money in the bank, you're
entitled to that money whenever you want.
That's the promise that's been made.
The bank takes that money and lends.
It lends to people for mortgages for 30 years,
for cars for 5 or 7 years, for all these
loans that are a long time. So they have a
mismatch of their timing between what they owe you
and your deposits immediately and what they
own, which are these assets that are long term
. Liquidity is when a bank has a crunch.
Generally depositors want their money
immediately and the bank has more demands for that
immediate money than they have assets that
they can liquidate in order to get people their
money so they fail due to a crisis of liquidity.
It was ultimately liquidity that caused SVB
to become the second largest bank to fail in
American history.
Do you remember when you could get a mortgage at 3
% or 4%? That mortgage got put into a big pool
and SVB was one of the buyers of that.
Now, when interest rates rose sharply, those cheap
mortgages were worth less.
When people are afraid that a bank doesn't have
as much capital, that its assets aren't there,
they become jittery and they want their money and
they try to make a deposit run.
So a handful of businesses wanted their
money. SVB had a liquidity problem.
That was immediately why it failed.
There was a run on the bank.
No bank can withstand everybody asking for its
money back at the same time, right?
And that happened.
Once a bank fails, the Federal Deposit Insurance
Corporation steps in.
First established in 1933, the organization
was created in order to protect depositors and
improve trust in the American banking system.
The FDIC, this is their kind of bread and butter.
They know how to unwind a bank in kind of the the
least harmful way.
For most banks, FDIC attempts to sell the
failed bank in whole or in part to another bank
in healthy standing.
Another bank comes in and will take over all of the
loans or most of the loans of the bank and
their deposits.
And if there's a mismatch between the
loans and investments that they're getting and
the deposits that they're getting, then the
FDIC may have to put some money into the pot
to make it attractive for another bank to take
that over.
In other cases, FDIC takes a more involved
approach.
In the case of Silicon Valley Bank, what they
did is take possession of the bank and then
basically create what they call a bridge bank.
And the idea of this bridge bank is to get the
depositors their money and then collect on any
loans that they might have. In essence, what
they're going to do is liquidate this bank so
that the bank no longer exists.
Regardless, depositors in FDIC insured banks are
covered up to $250,000 per depositor per bank
for each account ownership category.
Insurance also plays an important role in
preventing panic among depositors.
The whole purpose of deposit insurance, which
is what the FDIC was created to do, is to say,
okay, the reason why you're trying to pull out
your money is because you think if you wait too
long and this bank fails, your money won't
be there. So what if we back your money and we
say even in the case if this bank was to fail, we
will insure you up to a certain point?
However, not all banks are FDIC insured.
Yet the federal government made a
controversial move in 2023 when they announced
that all depositors of SVB, including more than
95% who were uninsured, would continue to have
access to their money.
I'm very concerned that we're setting a precedent
towards unlimited government support for
every dollar in the banking system.
There's now an expectation in a similar
event they would do the same thing.
And if that's the case, it really needs to be
addressed in a much more comprehensive way.
That would presumably involve raising the
deposit insurance limits and having the deposit
insurance premiums reflect that accordingly.
Nonetheless, a swift action from the
government is vital to containing bank failures
that could lead to a domino effect.
How much could this spread?
From lessons learned in the past from banking
regulators and financial crises, the quicker you
move to ring fence or isolate this incident
from other banks, the less likely there is of a
contagion effect, Andrea. That's probably
the reason why you saw the FDIC and California
regulators act as quickly as they did with
SVB.
There's definitely the potential for dominoes,
and the dominoes are, well, if we don't know if
this bank solvent, what's the next?
Sometimes it's an oil crisis or a farm crisis,
housing market and the great financial crisis.
These are all things that large numbers of
banks have exposed to.
You have banks that are doing the same things
that at one point might have seemed safe, but at
the extremes are not safe.
And then something triggers it so that those
dominoes start to fall.
Bank failures can have a major impact on the
American economy.
All we have to do is go back to the financial
crisis of 2008, the failure of those
financial institutions.
It greatly restricted and constricted the
economy.
Banks have to conserve their capital.
They do that by tightening their lending
standards. And as they tighten their lending
standards, there's less credit flowing through
the economy. And that contraction of credit is
a negative impulse to economic growth.
It can trigger either economic slowdowns or,
more seriously, could lead us into economic
recessions.
So are there enough regulations to prevent
and buffer against bank failures?
Experts say that's the wrong question to ask.
People are asking the question, did we get the
rules, right? Well, there's a more elementary
question. Did we enforce the rules right?
And the answer is no.
If you look at what the regulators were doing
with SVB as recently as 2019 and more recently
even, they were warning that things need to be
changed here, that they're taking on
additional interest rate risk, that they're going
to have some potential liquidity problems in the
event that interest rates begin to rise.
There were failures of supervision done by the
Federal Reserve.
Obvious and rampant throughout Silicon Valley
Bank and potentially others.
The collapse of SVB also revealed the danger of
deregulation. Several politicians and
researchers have openly blamed the rollback of
Dodd-Frank regulations as one of the main
reasons for its failure.
We start doing what's known as stress tests,
where the Federal Reserve, you know, create
these hypothetical situations of like our
economy in distress in various ways and then
like use these simulations for the bank
and based on how the bank is right now, how
will you survive a period of stress, right?
So we start doing all these things and it's
great. And then literally on the 10th
year anniversary of Dodd-Frank passing 2018,
we see under the Trump administration, there is
now this call to deregulate a bit, right?
What we're doing today with respect to
Dodd-Frank is truly important legislation.
And I have to say for a Congress that they say,
you know, won't be doing much because we have an
election coming up, I think we're doing an
awful lot when you think about it.
They raised the limit up to 250 billion that were
subject to some additional scrutiny from
50 billion. And so SVB happened to fall in that
category of between 50 billion and 250.
So when they raised that to 250, they weren't
subject to this greater scrutiny.
Deregulation is not the answer, right?
We keep trying that and we keep failing.
Right? So at some point, like we need to stop this
game that we're playing with ourselves.
Panic is never the right reaction following a
bank's collapse.
Nonetheless, there are always lessons to be
learned from it.
All in all the US banking system is safe and sound
. For individuals, though, it doesn't hurt
to take a look at the financial health of your
financial institution, your bank.
If you happen to have more than the insured
amount, and unless you're having to make
payroll, you know, if it's your savings that
we're talking about, then it might make sense
for you to spread that money out just for your
peace of mind.
Because if you are banking with a small
community bank and something were to happen
to that bank, it's unlikely, but if
something were, it's unlikely that the
regulators are going to come in and guarantee all
of your deposits. They would only be
guaranteeing up to that $250,000.