17th Mar 2023 by Pushpendra Mehta, Executive Writer, CTMfile
COVID-19 dominated 2020, supply chain disruption dominated 2021, and the Russia-Ukraine war and the interest rate shock dominated financial markets in 2022. As if this wasn’t enough, the failure of two US banks is likely to dominate the upcoming chatter on Capitol Hill, as well as with lawmakers, economists, investors, CEOs, CFOs and corporate treasurers.
Two banks failed within two days of each other. On March 10, Silicon Valley Bank (SVB) collapsed after a bank run (depositors withdrew US$42 billion in a single day), becoming the second-biggest bank failure in US history and the largest since the 2008 global financial crisis. Barely 48 hours after the demise of SVB came the third-largest bank failure in the US ever, with Signature Bank being shut down by regulators to prevent a potential banking crisis. This all came less than a week after Silvergate Bank, while not taken over by regulators, announced it would voluntarily wind down operations and liquidate its assets to repay depositors, adding to the general nervousness.
As per the Federal Deposit Insurance Corporation (FDIC), 563 US banks have failed since 2001 (see chart below), with the largest bank failure being Washington Mutual Bank in 2008.
Summary of Bank Failures (2001-2023)
Fifteen years later, the startling closure of two banks has regulators, bankers, business leaders, finance chiefs and corporate treasurers worried and markets rattled. What is likely to come next?
The risk of a broader financial contagion
In a bid to calm nerves and contain the risk of widespread contagion culminating into a potential banking crisis, the US Federal Reserve (Fed), Treasury Department and FDIC announced steps to ensure that all SVB and Signature Bank depositors will be paid in full. These funds will come from the FDIC’s Deposit Insurance Fund (DIF).
“The Deposit Insurance Fund is bearing the risk. This is not funds from the taxpayer”, a senior Treasury official said.
The DIF is funded primarily by quarterly fees assessments on FDIC-insured banks, as well as interest on funds invested in US government bonds, and currently has over $100 billion in it, according to the Treasury official.
In addition to protecting depositors of Signature bank and SVB, the Fed has launched a $25 billion Bank Term Funding Program (BTFP) to ensure that eligible banks and depository firms have adequate liquidity to cover the needs of all depositors.
The BTFP will offer loans of up to one year in length to banks as well as savings associations, credit unions and other eligible depository institutions that pledge “U.S. Treasuries, agency debt and mortgage-backed securities, and other qualifying assets as collateral. These assets will be valued at par. The BTFP will be an additional source of liquidity against high-quality securities, eliminating an institution’s need to quickly sell those securities in times of stress”, as per the Federal Reserve Board.
As the news of the collapse of Signature Bank and SVB reverberated around the world, the US government raced to shore up the financial system and restore faith in its banks. Customers fearful of a spreading banking crisis sought safety and deposit refuge in financial institutions seen as too big to fail. Emerging as one of the big winners after the shutdown of the two smaller banks, “Bank of America Corp. mopped up more than $15 billion in new deposits in a matter of days”, reported Bloomberg.
Despite the unleashing of various measures to stop a widespread financial crisis, fears of deeper problems in the international banking system are emerging. Credit Suisse, one of Europe’s largest banks, saw its stock lose more than a quarter of its value on March 15, hitting a record low after its biggest shareholder, the Saudi National Bank told media outlets that it wouldn’t inject more money into the bank. However, the troubled banking giant was offered a financial lifeline by the Swiss central bank.
The Swiss National Bank confirmed in an email on Thursday, March 16, that it “will provide liquidity to Credit Suisse against sufficient collateral”, an offer the beleaguered bank decided to accept. And while Credit Suisse announced it will be borrowing up to 50 billion Swiss francs ($53.7 billion) from the Swiss National Bank to stay afloat and restore confidence in its operations, investor nerves are still frayed. Experts believe Credit Suisse is not out of the woods yet, given that the bank found “material weaknesses” in its financial reporting as of the end of last year.
Meanwhile in the US, Moody’s Investor Services cut its outlook for the entire US banking system to “negative” from “stable” and placed six US banks on review for potential credit rating downgrades in the wake of the failures of SVB and Signature Bank.
The resilience of banks, particularly regional and midsized banks on both sides of the Atlantic, is under test. Investors are now worried that banks “have risks on their balance sheet that they don’t know about and therefore have accumulated significant losses that haven’t been yet realized”, as was recently reported by the Associated Press.
Given the interconnectedness of the financial system, the turmoil in the banking sector may cause a contagion that spreads to other banks, potentially cascading into a financial crisis. To avoid being pulled into any banking sector contagion and to stem the crisis of confidence, financial institutions worldwide will have to remain on constant alert for cracks in their own systems, particularly in a high interest rate environment.
Pause in Fed Rate Hikes
While inflation remains a potent threat to the real economy, the collapse of two banks and concerns about widespread financial damage might prompt the Fed to not raise interest rates at its March 21-22 meeting.
Experts believe that the Fed will hold rates flat until the markets have settled and concerns around the broader financial sector stress have been assuaged. Some Wall Street economists seem to be projecting a quarter-point hike still. However, Goldman Sachs economists do not expect the Fed to deliver a rate increase next week, but are looking at quarter-point increases in May, June and July.
US inflation may have eased, but it is still elevated, and that puts the Fed in a tough spot. Do they fight inflation and stay focused on price stability, or sideline rate hikes for now to give the financial system time to stabilize?
In a recent ICD webinar aptly entitled “Banking Turmoil: What Treasury Needs to Know”, Anthony Carfang, Managing Director of The Carfang Group, observed, “This is going to be interesting. We’re going to see whether the government wants full employment and a growing economy in the short-term or wants to break inflation in the short-term to have higher employment and a growing economy down the road. That’s really the trade off.”
With inflation still a cause of concern, the Fed may not have the luxury to delay a hike, but holding off on an increase may be its immediate focus to prevent financial mayhem. “We think Fed officials are likely to prioritize financial stability for now, viewing it as the immediate problem and high inflation as a medium-term problem”, Goldman told clients in a note.
Many agree that this bank chaos was triggered by bad risk management practices around interest rates and deposit management. The 2008 financial crisis sparked stringent regulation, including the Dodd-Frank Act. The Trump administration later watered down the Dodd-Frank Act and limited regulation on small and midsize banks, reducing scrutiny many believe might have averted SVB’s and Signature Bank’s failures.
The current US President has said he will ask Congress and the banking regulators “To strengthen the rules for banks, to make it less likely this kind of bank failure would happen again, and to protect American jobs and small businesses.” This means that stronger banking regulations governing risky bank behaviour are expected to be put in place, and that means a likely repealing of the 2018 legislation that rolled back significant parts of the Dodd-Frank Act.
In conclusion, regulators and central banks around the world will be keeping a strict vigil and taking necessary steps to prevent the US banking failures from snowballing into a financial crisis. For now, the US government’s intervention seems to have helped contain the damage to the financial system, and the country’s biggest banks are better capitalized and hold more liquidity in the aftermath of the 2008 global financial crisis.
Executive Writer, CTMfile
Pushpendra Mehta is Executive Writer at CTMfile responsible for creating content that pertains to the world of cash and treasury management, finance and economics sector. He has served as a writer and marketer for varied businesses, including online news media and digital publishing, global economic research and forecasting, and bankcards and consumer finance consulting. Pushpendra has worked with teams spanning North America, Western Europe, the U.K., Asia Pacific, and Latin America. He is the author of four books, and is an alumnus of Northwestern University, IL.