On March 22, Federal Reserve Bank Chair Jerome Powell announced that the U.S. central bank was raising interest rates again, this time by a quarter point, to slow down inflation despite continued nervousness from the recent banking crisis. From Powell’s perspective, the collapse of Silicon Valley Bank (SVB) was an anomaly, and the bank had been in trouble for a while. Silvergate Bank collapsed due mainly to its bets on cryptocurrency, with FTX being one of its customers. Has the recent banking crisis reached its zenith, or is it just the beginning of a more widespread meltdown?
To gain a better perspective on the current banking situation, we asked two Georgia Tech Scheller College of Business professors, Jonathan Clarke, senior associate dean of programs and associate professor of Finance, and Alex Hsu, associate professor of Finance, to weigh in on how inflation is tied to banks, why SVB and others failed, and if more may follow.
How are U.S. banks tied to inflation?
Clarke: Banks are impacted by interest rates and inflation rates. The Fed has raised rates quickly, from 0% to close to 5%, to combat inflation, and this has a negative impact on asset prices, especially bonds with longer maturities. Silicon Valley Bank (SVB) had significant losses on its long-term bond portfolio. At the end of 2022, for example, the bank had approximately $15 billion in unrealized losses on its investment portfolio.
Hsu: The Federal Reserve Bank raised interest rates aggressively over the last year to combat high inflation, which caused fixed-income assets such as bonds and mortgage-backed securities to lose value. SVB happened to hold many of these assets on its balance sheet. On the liability side, SVB had many deposit accounts from startup companies exceeding the $250,000 FDIC insurance limit. As its assets lost value due to the climbing interest rate, SVB became insolvent, and its depositors panicked.
The key, though, is to remember that, unlike the 2008 financial crisis, there is nothing wrong per se with the fixed-income assets themselves in the current episode. Had SVB been allowed to hold these assets to maturity, their value would have recovered.
Was the collapse of SVB influenced by investors making a run on the bank?
Clarke: SVB had roughly $173 billion in customer deposits at the end of 2022. Of these deposits, about $152 billion were uninsured because they were over the FDIC’s $250,000 insurance threshold. This huge percentage of uninsured deposits increased the likelihood of a bank run at SVB.
What else could cause a run on a bank?
Clarke: Social media can definitely fuel a bank run. According to various reports, SVB was tweeted around 200,000 times on Thursday, March 9. On that same day, customers withdrew $42 billion, a staggering sum of money. By March 10, the bank had failed.
Do you see other smaller to mid-sized banks failing in the next few months?
Hsu: No, the Fed and large banks like JPMorgan Chase and Bank of America intervened. The Fed established the Bank Term Funding Program to allow small banks to borrow essentially cash at very favorable rates. Chase and Bank of America have also teamed up to deposit funds into small banks.
Why would investors from banks such as First Republic, Signature Bank, and Western Alliance want to withdraw their deposits once they saw SVB go under?
Clarke: Generally, banks borrow short-term from depositors and lend money long-term. These long-term loans have experienced significant losses as the Fed has raised rates. It seems that SVB was exceptionally bad at managing this duration risk. There’s a concern in the market that other regional banks are similarly exposed to duration risk similar to SVB.
Is a smaller bank dependent on one or two large clients to keep them from going under? If so, why?
Clarke: It wasn’t one or two large clients that caused problems at SVB. Rather, SVB had a high reliance on corporate and venture capital deposit funding in general. Very few of SVB’s customer deposits came from small, retail clients.
Is it just a coincidence that a European bank, Credit Suisse, was also failing, or is there a direct connection between U.S. banks and the international banking community, and if so, what other banks may be on the brink?
Clarke: Credit Suisse needed a $44 billion loan from the Swiss National Bank, but their problems started well before the SBV collapse.
Hsu: Over the years, Credit Suisse has been fined large sums by regulators. It made bad investment decisions which caused it to lose billions of dollars. The banking crisis in the U.S. led investors to examine the solvency of Credit Suisse, which then triggered its demise.
Should the average consumer worry about their money? We know FDIC protects them, but the 2008 crisis affected the average consumer’s savings.
Hsu: No. The FDIC already promised to make depositors of SVB whole. The federal government is singularly focused on preventing runs on banks.
What more could federal regulators do to prevent this from happening again?
Hsu: The Fed does "stress testing" on banks periodically. They apply different scenarios to see if a bank under scrutiny can withstand adverse economic conditions. However, the Fed failed to consider large interest rate increases in such a short time span, roughly 4.5% in one year during the current tightening cycle. This will change going forward.
Are we heading towards another 2008?
Hsu: No. Bad assets, particularly mortgage-backed securities and insurance contracts written on them, were at the core of the 2008 financial crisis. Institutional investors and banks bought these assets thinking they were triple-A investments. When the housing market crashed in 2008, these assets became worthless.
This time, there is very little concern about the financial assets themselves. However, by construction, fixed-income assets lose value when the interest rate increases. As they approach maturity, they will recover in value.