Since March, two regional banks – Silicon Valley Bank and Signature Bank – have failed. Earlier this month, a third regional bank, First Republic, was on the brink of collapse before the government took control and sold it to JP Morgan Chase. Then there were questions about the stability of a fourth regional bank, PacWest Bancorp, which has appeared to weather the storm.
While the regional banking system remains uncertain, Silicon Valley Bank and Signature Bank executives testified on their banks’ failures before the Senate last week.
To get a better understanding of the current turmoil the regional banking system is facing, Drexel News Blog spoke with Gregory Nini, PhD, an associate professor of Finance in the LeBow College of Business and expert on financial institutions, corporate finance and capital markets. He explains why banks have been failing and the hope for stabilization.
Why did Silicon Valley Bank and Signature Bank fail?
Banks face two types of risk that have both materialized over the last year. First, the sharp rise in interest rates caused a fall in the value of the assets that banks own. Banks made a lot of mortgages at interest rates below 4%, and when mortgage rates increased to nearly 7%, those previously granted mortgages became worth considerably less. This has caused the stock prices of many banks to decrease.
Second, banks face the risk that many of their depositors withdraw their money at the same time. Since banks only have limited access to cash, banks can be unable to meet these redemptions. Ultimately, the inability to meet customers’ withdrawals causes a bank to fail.
Why are depositors withdrawing their money?
Two factors can cause depositors to withdraw their deposits from a bank. First, depositors may realize they can earn higher interest rates by moving their money from bank accounts to alternative investments such as money market mutual funds.
Second, depositors withdraw their money when they fear that their bank may not have the funds to repay them. The second factor is particularly important for uninsured deposits – above $250,000 – since the FDIC doesn’t promise to make the depositor whole. Uninsured deposits have been the first to pull their money from banks.
Larger, national banks have appeared to be okay in this recent turmoil. Why has this only affected smaller, regional banks?
Silicon Valley Bank (SVB) was uniquely exposed to each of these risks. SVB had a large portfolio of long maturity assets that fell in value when interest rates rose, and since SVB’s depositor base was mostly uninsured and concentrated in a few places and industries, SVB experienced unprecedented withdrawals over the span of just a couple days.
Large banks are deemed too-big-to-fail, so depositors at large banks do not fear losing money, even if their deposits are uninsured. Indeed, some of the depositors leaving the regional banks are moving their deposits to large banks due to the perceived safety of the large banks. This is why the crisis has been concentrated in regional banks.
Why does failure seem to be “contagious” – first Silicon Valley Bank then Signature Bank, and potentially other regional banks?
Many banks have suffered large stock price declines because they are exposed to the same risks as SVB, though to a lesser extent. The rise in interest rates has hurt the asset values and profitability of most banks, and depositors have been pulling their money from many regional banks. Part of the contagion reflects the common exposure to the same underlying risks.
The other source of contagion is harder to quantify and predict, but a critical concern for banks is that depositors withdraw their money en masse based on some piece of bad news, no matter how small the news might be. For SVB, the news appears to have been a failed capital raise. But the news could be a bad earnings report, a fall in the stock price, or even the failure of a different bank. If the failure of one bank spooks the depositors at a different bank, then failures can be “contagious.” My guess is that PacWest and other large regional banks survive, but it’s certainly possible that something spooks depositors and another run happens.
Silicon Valley Bank and Signature Bank executives testified before Senate last week. Will that have any impact on this issue?
I don’t expect the Senate testimony to lead to anything substantial in the short run, but I think it will add to the collection of evidence that the public is gathering about the experience. The Federal Reserve, the Federal Deposit Insurance Corporation (FDIC), and the California Department of Financial Protection and Innovation (CA DFPI) have recently produced reports about the failure of SVB, and academics have already started analyzing the episode. My guess is that we will see changes to regulation and supervisory oversight of banks, but it will take some time to implement.
Is there anything else about these recent issues that is important?
The one other issue that is relevant is the extraordinary response from the Federal Reserve and FDIC. Regulators provided unlimited deposit insurance for SVB and Signature Bank. The Fed created the Bank Term Funding Program to provide loans to banks to replace lost deposits, and the Fed made the discount window – also a program to lend money to banks – a bit more generous.
The goal of these initiatives is two-fold. First, the programs provide banks access to funds to better handle customer withdrawals. And second, by providing banks with tools to meet redemptions, regulators are hoping to prevent depositors from withdrawing in the first place. If customers can be confident that their money is safe, they are less likely to run on their banks. As time passes without another failure, I suspect depositors become more confident in the system and future failures become less likely.
Media interested in speaking with Nini should contact Annie Korp, assistant director, News & Media Relations, at 215-571-4244 or amk522@drexel.edu.