When Banks Fail

By Saurabh Kumar

Over the last several weeks, investors and depositors throughout the world spun into a state of fear surrounding the safety of their deposits as major banks in the US and other countries came face-to-face with disaster. 

On March 10, Silicon Valley Bank (SVB) failed after depositors made a run on the bank, marking one of the biggest bank failures since 2008, according to The New York Times. SVB was not alone. Two other major banks—Signature Banks and Silvergate Bank—also fell. What makes SVB a major development is its role as the major financial services provider for many of the country’s startup business. With such a pivotal role, its collapse sent a ripple effect through the rest of the economy, with even major institutions like Credit Suisse being forced to take stark measures.

While there are a number of factors that contributed to the initial downfall of these banks, some resounding reasons show the trend may have started months ago with the very structure of banks. 

As tech companies—who previously were seeing massive inflows of capital from hopeful investors—began to witness slower growth, many began to withdraw their deposits from their banks. In the case of SVB, depositors withdrew far more than the bank had available to repay. SVB alone issued $21 billion in bonds in an attempt to repay depositors, sending investors into a panic as the bank took losses of almost $2 billion. 

SVB is not alone in experiencing large losses. With the backdrop of rapidly increasing interest rates since the pandemic in an effort known as quantitative easing (Read: Interest Rates Here & Interest Rates There… So What?) aimed at speeding up economic recovery and combating heavy inflation, many banks have been holding unrealized losses on their balance sheets that have thrown depositors and investors alike into an uncertain state, according to The New York Times.

From an FDIC estimate, at the end of 2022, banks throughout the United States were holding more than $600 billion in unrealized losses as a result of the continued increases in interest rates. Despite built-in safety measures instilled after The Great Depression and 2008 Financial Crisis, the losses amassed by the end of the year became so outsized that the security of depositors’ capital was put into question. In a panel discussion hosted by NYU Stern, Professor Viral Acharya described that this risk could be foreseen using SRISK, a metric also developed at NYU Stern used to predict an entity’s under-capitalization. This and other indicators failing to spur a great enough response from executives and regulators raises concern about the efficacy of the present safeguards.

Though the risk was shown to be on the rise, many also have pointed out failures in the regulations meant to stop exactly this type of event from unfolding, looking at key events that led to the collapse of SVB. The bank grew rapidly with depositors focused on high-risk industries including tech and crypto, leaving it vulnerable to volatile shifts in market conditions, heightened once the cost of borrowing began to rise. 

The future of the banking industry at large has been the topic of discussion for many analysts, journalists, investors, and others, such as startup executives and founders who are feeling the effects acutely as they scramble to reconcile missed payments and an overall slowdown in funding. While many believe that the worst scenarios have been narrowly avoided, the issue is yet to be resolved as other banks continue to struggle with unrealized losses and exposure to volatile industries. The actions of the Federal Reserve will be critical both in putting an end to the current turbulence and reinstating confidence among depositors, with many ultimately putting the blame on the governmental body for not acting soon enough, despite seemingly clear warning signs.

In the short term, there may be some pain. CNN reports that small banks are undergoing a record drop in deposits, putting pressure on them while shifting more deposits to larger banks and other financial instruments such as money market accounts. While the situation has stabilized, according to Federal Reserve Chair Jerome Powell, it may well take time for people to regain the confidence necessary for some banks to regain their footing. 

Though to date, this tumble has not been as systematic and widespread as the 2008 financial crisis, questions about the Fed’s aggressive rate hikes and failure to regulate clear risks will no doubt loom on peoples’ minds for some time to come.