Almost a year after the mini banking crisis in the United States, it is worth revisiting the episode. Was it just a tempest in a teacup? Was there really a systemic threat, or was it just a problem with a few banks? Should the interventions by the U.S. Federal Reserve and Treasury worry or comfort us?
Recall that three mid-size U.S. banks suddenly failed around March 2023. The most prominent was Silicon Valley Bank, which became the second-largest bank failure in U.S. history, after Washington Mutual in 2008. Roughly 90% of the deposits at SVB were uninsured, and uninsured deposits are prone to runs. Making matters worse, SVB had invested significant sums in long-term bonds, the market value of which fell as interest rates rose. When SVB sold some of these holdings to raise funds, the unrealized losses embedded in its bond portfolio started coming to light. A failed equity offering then triggered a classic bank run. It is convenient to think that these issues were confined to just a few rogue banks. But the problem was systemic. When the Fed engages in quantitative easing (QE), it buys bonds from financial institutions. Typically, those sellers then deposit the money in their bank, and this results in a large increase in uninsured deposits in the banking system. On the banks’ asset side, there is a corresponding increase in central-bank reserves. This is stable, since reserves are the most liquid asset on the planet and can be used to satisfy any impatient depositors who come for their money. Unfortunately, a number of smaller banks (with less than $50 billion in assets) moved away from this stable position as QE continued. Historically, smaller U.S. banks financed themselves conservatively, with uninsured demandable deposits accounting for only around 10% of their liabilities. Yet by the time the Fed was done with its pandemic-era QE, these banks’ uninsured demandable deposits exceeded 30% of liabilities. Though that level was still far below SVB’s, these institutions clearly had drunk from the same firehose. Smaller banks were also more conservative about liquidity in the past. At the outset of QE in late 2008, banks with less than $50 billion in assets had reserves (and other assets that could be used to borrow reserves) that exceeded the uninsured demandable deposits they had issued. By early 2023, however, they had issued runnable claims (in aggregate) that were one and a half times the size of their liquid assets. Instead of holding liquid reserves, their assets were now more weighted toward long-term securities and term lending, including a significant share of commercial real-estate (CRE) loans. Thus, as the Fed raised interest rates, the economic value of these banks’ assets fell sharply. Some of the fall was hidden by accounting sleight of hand, but SVB’s sudden demise caused investors to scrutinize banks’ balance sheets more carefully. What they saw did not instill confidence. The KBW Nasdaq Bank Index duly fell by over 25%, and deposits started flowing out of a large number of banks, many of which lacked the liquidity to accommodate the sudden outflows. The risk of contagious runs across smaller banks was real, as was the possibly of the problem spreading more w …
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Recall that three mid-size U.S. banks suddenly failed around March 2023. The most prominent was Silicon Valley Bank, which became the second-largest bank failure in U.S. history, after Washington Mutual in 2008. Roughly 90% of the deposits at SVB were uninsured, and uninsured deposits are prone to runs. Making matters worse, SVB had invested significant sums in long-term bonds, the market value of which fell as interest rates rose. When SVB sold some of these holdings to raise funds, the unrealized losses embedded in its bond portfolio started coming to light. A failed equity offering then triggered a classic bank run. It is convenient to think that these issues were confined to just a few rogue banks. But the problem was systemic. When the Fed engages in quantitative easing (QE), it buys bonds from financial institutions. Typically, those sellers then deposit the money in their bank, and this results in a large increase in uninsured deposits in the banking system. On the banks’ asset side, there is a corresponding increase in central-bank reserves. This is stable, since reserves are the most liquid asset on the planet and can be used to satisfy any impatient depositors who come for their money. Unfortunately, a number of smaller banks (with less than $50 billion in assets) moved away from this stable position as QE continued. Historically, smaller U.S. banks financed themselves conservatively, with uninsured demandable deposits accounting for only around 10% of their liabilities. Yet by the time the Fed was done with its pandemic-era QE, these banks’ uninsured demandable deposits exceeded 30% of liabilities. Though that level was still far below SVB’s, these institutions clearly had drunk from the same firehose. Smaller banks were also more conservative about liquidity in the past. At the outset of QE in late 2008, banks with less than $50 billion in assets had reserves (and other assets that could be used to borrow reserves) that exceeded the uninsured demandable deposits they had issued. By early 2023, however, they had issued runnable claims (in aggregate) that were one and a half times the size of their liquid assets. Instead of holding liquid reserves, their assets were now more weighted toward long-term securities and term lending, including a significant share of commercial real-estate (CRE) loans. Thus, as the Fed raised interest rates, the economic value of these banks’ assets fell sharply. Some of the fall was hidden by accounting sleight of hand, but SVB’s sudden demise caused investors to scrutinize banks’ balance sheets more carefully. What they saw did not instill confidence. The KBW Nasdaq Bank Index duly fell by over 25%, and deposits started flowing out of a large number of banks, many of which lacked the liquidity to accommodate the sudden outflows. The risk of contagious runs across smaller banks was real, as was the possibly of the problem spreading more w …nnDiscussion:nn” ai_name=”RocketNews AI: ” start_sentence=”Can I tell you more about this article?” text_input_placeholder=”Type ‘Yes'”]