You have likely seen the news that Silicon Valley Bank failed last Friday and was taken over by the FDIC. On Sunday, the FDIC also took over Signature Bank and announced policy measures intended to shore up confidence in the banking system.
We don’t have all the details on the Silicon Valley Bank failure yet, but it looks like extremely poor judgment by management ultimately led to the collapse of the bank and acted as the catalyst for a classic run on other banks.
So what happened?
Like all banks, Silicon Valley Bank (SVB) owned a portfolio of bonds (mostly Treasury and Agency Mortgage Securities) that it was holding at unrealized losses. The losses materialized when interest rates began to increase last year. Not a problem by itself.
Unrealized losses on bonds on bank balance sheets only become a problem when they are realized.
What would make a bank turn unrealized losses on bonds into realized losses?
Banks are leveraged. They borrow money, mostly in the form of deposits, and use those funds to purchase bonds or make loans. Deposits often have short-term maturities, while bonds and loans have longer-term maturities.
SVB had a longer-than-average maturity profile in its bond portfolio. Longer bonds are more sensitive to interest rate increases. During the time unrealized losses on SVB’s longer-term bonds were piling up as a result of rising interest rates, the bank’s depositors were drawing down their balances. SVB’s depositors were mostly startups and VC-backed businesses, which have had a rough go of it since the Fed turned off the easy money spigot last year.
Typically, when a bank’s depositors draw down their balances, instead of liquidating bonds at a loss, the bank will try to replace those deposits. First, by offering more attractive interest rates to depositors, then by borrowing from the Federal Home Loan Banking System, issuing debt, or, if the situation becomes dire, borrowing from the Fed’s discount window. Realizing losses is usually a last resort scenario.
SVB took a different approach. Instead of seeking to replace low-cost deposits leaving the bank with other sources of funding, SVB decided to realize losses on a large portion of its bond portfolio and replenish its capital by issuing new equity.
That decision was a major misfire. It freaked out investors and depositors, which led to a failed capital raise and, ultimately, to a run on the bank which caused the FDIC to take it over.
Why would depositors pull their money from SVB when the FDIC provides insurance? Unlike most banks, almost all of SVB’s deposits were uninsured. When a bank fails, uninsured deposits are at risk of loss.
The failure of SVB caused many depositors, especially those with uninsured deposits, to reassess the safety of their deposits.
In other words, SVB’s failure started a classic bank run.
On Sunday night, to prevent a worsening of the situation, the government announced that it would make sure all depositors at both SVB and Signature Bank were made whole. You can likely take that as a signal that all deposits would be insured should any other bank fail for similar reasons. In conjunction with that announcement, the Fed announced a loan program to provide funding to banks so they don’t have to realize losses on their Treasury bonds if their deposit funding disappears.
The Fed loan program should eventually alleviate the liquidity crunch in the banking system. If it does not, one can envision the federal government backstopping all uninsured deposits in the banking system.
Even though a possible solution is in place, we may continue to see elevated levels of volatility in stock and bond markets as well as unsettling headlines. It is important not to panic. At this point, we are dealing with the type of classic liquidity crunch that the Fed was created to solve. The bonds causing problems for banks are not junk bonds or junk mortgages. They are full-faith-and-credit pledge Treasury securities and agency mortgage securities that will mature at par value. Patience is your number one ally today.
What Does the Liquidity Crunch in the Banking System Mean for the Safety of Your Deposits?
If you are an individual or a small business with less than $250,000 in the bank, there is no need to worry. Those deposits are insured. If you have a joint account, the FDIC will insure your deposits up to $500,000. The insurance levels are per depositor per bank. If you have funds spread across two banks, double those numbers.
If you have uninsured deposits, you have some decisions to make. Uninsured depositors at SVB and Signature were made whole. It is likely that if you have uninsured deposits at a bank that fails, you will also be made whole, but likely isn’t a guarantee.
For a guarantee, your first option should be full-faith-and-credit pledge Treasury bills and notes. A second option would be to open multiple bank accounts to stay under the FDIC limits. If neither of those is an option for you, consider banking with one of the systemically important banks such as JP Morgan, Bank of America, or Wells Fargo (there are others as well).