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Could Latest Bank Failures Threaten the Financial System?

As the fallout from the Silicon Valley Bank (SVB) crisis continues, many economists and market analysts are assessing the situation to determine the exact cause and what could happen in the coming months. With a potential contagion event in the broader banking sector, public policymakers and regulators are attempting to prevent a full-blown financial collapse that could mirror the Great Recession.

Deposit Risks

SVB’s collapse was driven by many factors, some of which could be found in other regional and national banks. For the Santa Clara-based financial institution, management attracted the heart of Silicon Valley—tech and venture capital firms and executives—by offering ultra-generous deposit rates that were much higher than larger competitors.

The bank funded these exorbitant rates by purchasing long-term and high-yield bonds when it maintained a healthy balance sheet. However, once the Federal Reserve initiated its quantitative tightening campaign, resulting in a cratering tech sector, the value of these instruments plummeted at an alarming rate.

SVB’s investments then suffered immense losses.

The company’s downfall was further exacerbated for two reasons. The first was a low level of deposits on hand. The second was SVB investing more of its capital in an attempt to keep covering its high deposit rates. Once the entity announced that it suffered $1.8 billion in asset sales and needed to raise more than $2 billion, SVB needed more investment capital and, as a result, depositors withdrew their money from the bank.

But while Signature Bank shuttered at around the same time as SVB, experts argue that its situation was slightly different. Because its clientele was similar to that of SVB—tech and VC companies—these worried customers withdrew $10 billion in one day, which led to a failure.

Signature Bank
A worker arrives at Signature Bank headquarters in New York on March 12, 2023. (Eduardo Munoz/Reuters)

For Silvergate Bank, which had been the cornerstone of the cryptocurrency ecosystem,  the California community bank shut down operations and launched voluntary liquidation due to “recent industry and regulatory developments.”

“The Bank’s wind-down and liquidation plan includes full repayment of all deposits,” Silvergate said in a statement.

Now that there have been three bank failures in a short time span, the balance sheets of these entities are being more closely scrutinized by financial experts. So far, dozens of banks, from Charles Schwab to Citibank, are sitting on significant unrealized losses.

Economist Mohamed El-Erian called this a case of “mismanagement” and bad policy.

“The 3 main factors behind the current market turmoil,” he wrote on Twitter. “Mismanagement at individual banks and supervisory lapses. A badly mishandled monetary policy transition complicating insufficient private/public sector adjustments. Policy-induced volatility amplifying economic/financial fluidity.”

Government Intervenes

The U.S. government announced on March 12 that the Federal Reserve, the Federal Deposit Insurance Corporation (FDIC), and the Treasury Department put together a plan to ensure that depositors have immediate access to their money.

The FDIC will cover all insured and uninsured deposits for customers at SVB and Signature. In addition, the FDIC will tap into the $128 billion Deposit Insurance Fund (DIF), a program funded by fees paid by banks. Experts say that regulators will need to employ extraordinary measures to pay off depositors since the SVBs maintain approximately $175 billion in total deposits.

Meanwhile, the U.S. central bank will employ lending facilities of up to one year for banks, savings associations, and credit unions impacted by the latest string of failures. The Fed will also allow banks to substitute their troubled assets for par value by pledging their assets in exchange for loans equivalent to the original value of the assets. This would eliminate any duration risks, but officials anticipate this move would instill confidence in the banking system.

For the most influential central bank in the world that is already posting negative income, this could be an economic risk.

The Treasury Department will additionally extend a $25 billion backstop in the event of losses.

“No losses will be borne by the taxpayers,” President Joe Biden said in prepared remarks from the White House on March 13. “Every American should feel confident that their deposits will be there if and when they need them.”

The Reaction

Since the U.S. government’s announcement, there have been mixed reactions from economists, market analysts, and public officials.

The government was “asleep at the switch,” David Rosenberg, founder and president of Rosenberg Research & Associates, posted on Twitter.

“Two days of testimony and not a peep about SVB from [Fed Chair Jerome] Powell. [Treasury Secretary Janet] Yellen on Friday on the banks being ‘resilient’ and yesterday with ‘no bailout’. Come again? We’re back to the 1970s all right—when it comes to economic leadership (or lack thereof),” he said.

Despite the delayed response, many celebrated the administration’s latest actions.

Bill Ackman, the founder and CEO of Pershing Square Capital Management, championed these efforts by arguing that they would inform depositors that the banking system is safe. He added that without these measures, taxpayers would be forced to foot the bill, and the plethora of regional and community banks would crumble.

However, Ken Griffin, the founder and CEO of Citadel, does not believe Washington should have taken these actions to shield SVB and Signature depositors from losses.

“There’s been a loss of financial discipline with the government bailing out depositors in full,” he told The Financial Times. “It would have been a great lesson in moral hazard. It would have driven home the point that risk management is essential.”

The risk of moral hazard—when one party is incentivized to take on risk without bearing the full cost of these risks—is what many money experts are discussing in the fallout.

Moral Hazards, Markets, and Credit Suisse

A chorus of critics has expressed concern about the fiscal soundness of these actions and the potential for unintended consequences and moral hazards. However, because the recent actions establish a considerable precedent, some contend that the Fed may continue to bail out ailing financial institutions to prevent widespread contagion, even if it breeds long-term risks.

Lawrence Lepard, an investment manager at Equity Management Associates, noted that the Fed’s balance sheet is $8.4 trillion, but the entire banking deposit base is $17.6 trillion. If the situation is exacerbated by other failures, such as the possible meltdown of Credit Suisse, the Fed would be on the hook for a significant sum.

“Did the FED just become the FDIC? Who eats the losses? Isn’t this [quantitative easing] infinity? Can the banks make any loan now consequence free knowing the FED will buy it if it goes south? I have questions,” he wrote on Twitter.

Since the central bank and the federal government are swooping in and curtailing the financial pain, this would also encourage banks to take on greater risk, says Genevieve Roch-Decter, the CEO of Grit Capital.

“But what about unintended consequences?” she asked on Twitter. “This potentially gives banks the go-ahead to take greater risks with our capital, knowing that the government will likely foot the bill in the end.”

The market instability is serving as a tremendous opportunity for the big banks because depositors might get spooked by smaller outfits and transfer their deposits to the more well-known institutions.

Deutsche Bank AG CEO Christian Sewing told Morgan Stanley’s European Financials Conference on March 15 that the bank has witnessed deposit inflows amid market volatility over the last four days. Walter Bettinger, the Charles Schwab CEO, revealed that his bank received $4 billion in fresh deposits at the height of the SVB panic. According to Bloomberg, Bank of America accumulated more than $15 billion in fresh deposits in the last few days.

But what if one of the big banks becomes the next domino to fall?

logo of Credit Suisse
Grey clouds cover the sky over a building of the Credit Suisse bank in Zurich on Feb. 21, 2022. (Ennio Leanza/Keystone via AP)

Credit Suisse shares cratered to an all-time low, plunging as much as 30 percent on March 15.

Saudi National Bank (SNB), the Swiss bank’s largest shareholder, announced it would not purchase more shares due to regulatory matters. The Saudi bank holds 9.88 percent of Credit Suisse shares.

The report came after the century-old bank confirmed that it discovered “material weakness” in controls over financial reporting and failed to curb the $120 billion worth of customer outflows seen in the fourth quarter.

But Credit Suisse CEO Ulrich Koerner confirmed in an interview with CNA’s “Asia Tonight” that “our liquidity basis is very, very strong.”

“We fulfill and overshoot basically all regulatory requirements,” he added.

This was not enough to stem concern as credit default swaps spreads connected to the company’s one- and five-year debt climbed to all-time highs. In other words, investors are betting that Credit Suisse will default on its debt.

As the financial and Treasury markets plunge, El-Erian says investors are learning that “banking is changing.”

“The equity market is realizing what the bond market has realized for the last few days,” he said in an interview with CNBC on March 15. “It’s not just one or two institutions. What we saw is exposing something much bigger that we have to reprice to, including that banking is changing.”

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