We tend to view banks as secure locations where our money is safeguarded behind locked doors, steel bars, and digital firewalls, but the reality is that they are inherently unstable. Banks make a profit by accepting deposits, lending money to borrowers, and earning interest on those loans. Therefore, the recent collapses of Silicon Valley Bank and Signature Bank are not entirely unexpected given the nature of the banking business model.
The rapid collapse of Silicon Valley Bank and Signature Bank resembled a classic bank-run scenario, where a large number of depositors withdraw their funds simultaneously. The speed of their failure was so astonishing that it could serve as a textbook example. These two banks' failures rank among the three largest in American banking history, after the 2008 downfall of Washington Mutual.
On Sunday night, regulators took sudden action to shut down Signature Bank to avoid a potential crisis in the wider banking system. The abrupt closures of these banks have caused significant disruption in the tech industry, as well as in Washington and Wall Street. As a result, the stocks of several regional banks experienced a sharp decline on Monday. However, on Tuesday, there was a brief moment of relief as bank stocks partially recovered their losses in early trading, easing some of the panics.
Silicon Valley Bank was a major provider of banking services to the US technology and life-science industries, as well as to venture capital firms. Like many of its competitors, it invested most of its deposits in long-term debt, such as Treasury bonds, which promised steady but modest returns.
However, this strategy proved shortsighted when interest rates started to rise due to rapid inflation. Additionally, the bank's concentration in the tech industry made it vulnerable to start-up funding fluctuations, leading to increased account withdrawals from clients.
The bank's reliance on uninsured depositors further exacerbated its financial difficulties, as it was forced to sell investments at a significant discount to meet customer demands. Silicon Valley Bank's eventual collapse triggered a bank run by panicked start-ups, resulting in its takeover by the Federal Deposit Insurance Corporation (FDIC) and the control of $175 billion in customer deposits.
The FDIC's responsibility is to maintain stability and public confidence in the US financial system. The failure of Silicon Valley Bank is the largest since the 2008 financial crisis, and some experts believe that regulatory measures like the Dodd-Frank package could have prevented such a collapse if they had not been reduced.
On Sunday, regulators closed Signature Bank to prevent a financial crisis in the wider system, just two days after Silicon Valley Bank was taken over by the FDIC. Signature Bank had deposits of under $100 billion across 40 branches in the country and had clients that included people associated with the Trump Organization.
The bank decided to take deposits of crypto assets in 2018, a decision that proved fateful after the FTX cryptocurrency exchange collapsed. Most of the bank’s clients had more than $250,000 in their accounts, and almost 90% of Signature Bank’s roughly $88 billion in deposits were uninsured at the end of last year. As Silicon Valley Bank’s issues began to spread, Signature Bank’s customers panicked and withdrew their deposits, causing the bank’s stock and that of some of its peers to plummet.
The fallout from the collapse of two banks in three days has prompted regulators to rush to contain it, causing a swift re-evaluation of the Fed's interest rate increases. Before the banks' collapse over the weekend, the Fed had been expected to increase rates by half a point at its upcoming meeting on March 21-22.
On Sunday, regulators announced the closure of Signature and reassured depositors of both Signature and Silicon Valley Bank that they would be fully
compensated and have access to their money by Monday. President Biden also assured the public on Monday that the financial system was stable and that their deposits were secure.
Treasury Secretary Janet L. Yellen acknowledged the situation on Sunday and reassured the public that the broader American banking system was safe and well-capitalized. However, she also acknowledged that many small businesses had funds tied up at the bank and suggested that an acquisition of Silicon Valley Bank could be a possible solution.
The F.D.I.C. started an auction for Silicon Valley Bank on Saturday, which was set to wrap up on Sunday. On Sunday, the F.D.I.C. invoked a systemic risk exception, allowing the government to pay back uninsured depositors to prevent dire consequences for the economy or financial instability.
Additionally, on Sunday, the Fed announced that it would establish an emergency lending program, with Treasury approval, to provide extra funding to eligible banks and ensure that all depositors' needs were met.
The failures of Silicon Valley Bank and Signature Bank highlighted the challenges faced by smaller banks that focus on specialized industries and are more susceptible to bank runs than larger banks. The main concern is that the failure of one bank could trigger fear in customers of other banks, leading to a domino effect of withdrawals.
Despite their relatively small size compared to larger banks like JPMorgan Chase, the sudden collapse of Silicon Valley Bank and Signature Bank caused shares of U.S. regional banks to plummet on Monday. In contrast, bigger banks like Citigroup and Wells Fargo were less affected, with the KBW bank index falling 10 percent and erasing nearly $200 billion from the aggregate value of the banks in the index.
Smaller banks rushed to reassure their customers that they were financially stable. First Republic Bank took the biggest hit, falling 60 percent, followed by Western Alliance in Arizona, which tumbled 45 percent, and KeyCorp, Comerica, and Zions Bancorp, which all experienced significant declines.
What happens next for people who had ties to Signature Bank and Silver Valley Bank?
According to federal officials, customers of Silicon Valley Bank (SVB) will have full access to their deposits, including accounts that held more than the FDIC insurance limit of $250,000. The majority of accounts at SVB held more than that amount, totaling $175 billion in customer deposits.
This move essentially guarantees these deposits. The officials also stated that deposits at Signature Bank will be backstopped, and operations at both banks resumed on Monday, allowing account holders access to their funds.
This means that companies relying on cash deposits at SVB for their daily operations, such as making payroll, can carry on as normal. However, the FDIC warns that shareholders and some debtholders will not be protected and senior management has been removed from their jobs.
Federal officials are taking steps to prevent a potential "contagion" from spreading to other banks, assuring customers that their deposits will be safe. President Biden confirmed this in a statement on Monday, stating that "the banking system is safe". The Federal Reserve Board has made funding available to other banks to help bolster their cash reserves and prevent a possible bank run. Despite these measures, the stock market experienced significant volatility on Monday, with government bonds becoming a popular haven for investors.
The drop in the 2-year Treasury yield, which reflects investor expectations about interest rates, has been particularly pronounced, falling from just over 5% to just under 4% since the middle of last week. This comes ahead of a Federal Reserve meeting next week, during which the Fed will decide whether or not to raise its benchmark interest rate again.
The Fed's rapid interest rate increases in recent months have helped to control inflation, but have also had a negative impact on bond holdings such as those invested in by SVB, which contributed to its collapse last week.
Prior to the collapse of SVB, the markets had expected the Fed to raise interest rates by half a percentage point at its March meeting. However, with pressure on the Fed to ease up on these increases, these expectations have since receded.
For many customers of these banks, the sudden closure has created a headache when it comes to finding new banking options. One of the most important concerns for these customers is whether they will need to obtain new routing numbers for their accounts. The good news is that both Signature Bank and Silicon Valley Bank have made it clear that customers will not need to obtain new routing numbers.
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Frequently Asked Questions
If a bank fails and your money is in an FDIC-insured account with less than $250,000, you will be protected and your money will be returned to you. The FDIC will typically arrange for your account to be transferred to another institution, or they will issue you a check for the amount you had on deposit. However, if you had more than $250,000 in a single account or across multiple accounts at the failed bank, you may not be fully covered by FDIC insurance and may lose some of your money.
The bank collapses have led to a drop in the 2-year Treasury yield, which generally reflects investors' expectations of where interest rates are headed. This has led to some pressure on the Federal Reserve to ease the rapid interest rate increases that have been implemented over the past year.
Banks can collapse due to various risks they face, including credit risk, liquidity risk, and interest rate risk. Credit risk arises when borrowers fail to repay their loans or when other assets held by the bank turn bad, causing them to cease performing. Liquidity risk occurs when depositors withdraw more money than the bank has on hand, leaving it unable to meet its obligations. Interest rate risk is another major risk that banks face.
When interest rates rise, the value of bonds held by the bank declines, and the bank may have to pay more on its deposits than it receives on its loans. In addition to these risks, banks may also face operational risks such as fraud, technological failures, or management misconduct, which can also lead to their collapse.
The Federal Reserve has been closely monitoring the situation and has made funding available to other institutions to help prevent a "contagion" from spreading to other banks. They are also set to announce whether they will raise their benchmark interest rate again at an upcoming meeting.