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Last week the US experienced the second and third-largest bank failures in our country’s history. These failures have raised concern and scrutiny about the rest of the banking world, with regulators, bank customers, and bank investors wondering if there is more risk with their bank than they previously understood. The failures have also shined a bright light on other banks that might be at risk of failure, both in the US and overseas.
While there is no indication of a large-scale systemic risk to the banking sector, any notable bank failure will raise concerns at many levels. Moreover, we don’t believe this is 2008 all over again when the banking sector created a financial crisis. Banks are much better capitalized and monitored, and regulators are quicker to step in to protect the financial system. However, banks are adjusting to an uncertain economic outlook and higher interest rates, which may be challenging for some. Banks that maintain healthy balance sheets and proper controls and liquidity should still be successful in this more challenging environment.
The failed banks had different backgrounds but highlight the same issue: management matters. Both banks were compliant with industry regulations but disregarded some basic banking standards. After the failures, a joint statement from the Treasury Department, Federal Reserve and Federal Deposit Insurance Corp. was released on Sunday, stating that the government would guarantee the deposits of all bank customers in an effort to stem a further run on banks and restore confidence to the sector.
Silicon Valley Bank: The short story about the demise of Silicon Valley Bank (SVB) is that their management made some truly poor decisions that led to a run on the bank. SVB had a very concentrated investor base, serving many venture capital firms and start-ups. Ultimately they had two problems: uninsured deposits and cash management. Banks keep the vast majority of their cash in short-term instruments to provide enough liquidity for customers to withdraw funds. SVB, for some reason, decided to hold a much higher-than-average amount of its assets in longer-term bonds, which lost substantial value as interest rates increased over the past year. As their tech-focused customers withdrew cash recently, SVB decided to sell $21B of these bonds at a $1.8B loss and also raised capital to meet their withdrawal needs. Instead of reassuring customers, the surprise moves scared them. Since only $25B of their total $200B was insured under FDIC insurance, depositors got nervous and pulled their funds out, creating a run on the bank. The management team should have seen this obvious risk and could have prevented such drastic events.
Signature Bank: The SVB failure incited a run on deposits at Signature Bank, which focused on the highly volatile cryptocurrency industry. After the recent failure of crypto exchange FTX and the liquidation of crypto bank Silvergate, Signature customers got nervous as SVB failed. With about 90% of Signature Bank’s accounts uninsured, a run on its deposits could have created a systemic risk to the financial system, so regulators closed it over the weekend.
WHAT TO WATCH
The stability of most parts of the financial industry depends on the confidence of those who participate in it, and that is certainly true of the banking industry. This is one of the reasons that the government declared that banking depositors would not lose any of their funds. There are three main areas to watch as events unfold over the coming weeks: backstopping, the Fed, and the investment landscape.
Backstopping: We have already seen – and are likely to continue seeing – large, well-capitalized organizations backstopping banks that have become a concern. On Thursday, eleven US banks deposited $30B into First Republic Bank to provide support as it came under pressure from its customers. In Europe, beleaguered bank Credit Suisse borrowed $50B from Swiss National Bank to shore up its assets. Additionally, private equity firms and other investors are circling SVB to determine how to salvage the bank’s assets and provide value.
The Fed: The real question is whether the Fed will raise rates next week. The Fed has been trying to break inflation by raising rates, but it does not want to break the economy or the financial system. Before the crisis, the consensus was that the Fed would raise rates by 0.50% next week. Earlier this week, some called for the Fed not to raise at all. The Fed is expected to rise by 0.25% next week, possibly ending its tightening cycle earlier. This could be good news, especially if inflation is truly starting to come down, as evidenced in recent economic data.
Investment landscape: The financial markets will likely continue to be volatile in response to news about the banking system and from the Federal Reserve. During times of crisis, investors love bonds. This has been evident since Friday, when bond yields dropped and prices rallied. The stock market – which tends to react emotionally to current events - is likely to continue to gyrate over the next few months as we better understand potential risks in the banking sector, how that may affect the economy, and how the Fed will react. These events will likely challenge the tech sector and the bank loan sector.
WHAT YOU CAN DO NOW
Despite the concerns all of us share about the potential risks in the banking sector, there has yet to be immediate action for most Americans to take. Times like these do remind us to review our assets in our bank accounts and investments and to stay informed.
Bank accounts: If you hold less than $250,000 in your bank accounts, you have FDIC protection. If you hold more than $250,000 in a bank account, you should ask your banker if you can divide the assets so you have more funds protected and also inquire about their financial stability. See the FDIC website for more details.
Investments: The failed banks were mid-sized and seem to be contained for now, but there are still concerns that additional bank failures could affect the investment landscape. If your portfolio met your risk and goal expectations before last week, there is no need to make a major shift in response to these events. As always, if you have heightened or new concerns about your investments, you should contact your advisor to make sure your portfolio matches your financial plan.
Stay informed: It’s wise in a time of uncertainty like now to stay in tune with how certain risks may affect your assets and financial resources. Regulators around the world are already scrutinizing how to shore up the banking sector, and we are likely to see new regulations around small- and mid-sized banks. We will continue to monitor the situation with caution and communicate to you if we see elevated or new risks.
If you have any questions, need a review of your portfolio, or have any topics you would like us to write about, please drop us a note at firstname.lastname@example.org.
Debra Brennan Tagg is a CERTIFIED FINANCIAL PLANNER™ Professional and the creator of the DBT360 Financial Plan, a proprietary program that helps her clients prioritize their goals, leverage their resources, and address their risks. She is the president of BFS Advisory Group and teaches the public and the financial services industry about the importance of values-based financial planning and investor education.