The recent collapse of Silicon Valley Bank has triggered a crisis of trust in the US banking sector. A survey shows that almost 190 US banks, accounting for 5% of all banks in the country, are at risk of collapse. The problem lies in the assets held on banks’ balance sheets, primarily US bonds and mortgage-backed securities, which can decrease in value when interest rates rise. A report by four U.S. academics shows that banks investing uninsured deposits in these assets could become insolvent temporarily, and the problem may intensify as interest rates rise. Some experts suggest cryptocurrency is a safe haven.
—
Understanding the Recent Crisis of Trust in the US Banking Sector
Introduction:
The recent collapse of Silicon Valley Bank has kick-started a crisis of trust in the U.S banking sector. Americans, and especially uninsured depositors, are scrambling to find out if their deposits are at risk.
The Study:
According to a recent survey, almost 190 U.S banks (5% of all the Banks in the country) are at risk of going under. That’s why today we’re going to summarize a study that reveals which risk factors to be on the lookout for, and tell you why crypto could be one of the only truly safe havens.
The study in question is titled “Monetary Tightening and U.S Bank Fragility in 2023: Mark to Market losses and uninsured depositor runs.” It was written by four academics from prestigious U.S universities and was published on the 13th of March. The link to the full study will be in the description.
The Risk Factors:
Now, the report begins with a brief explanation of why so many U.S banks are at risk of going under. This all has to do with the assets banks hold on their balance sheets, namely U.S bonds AKA U.S government debt, and mortgaged-backed securities or MBS’s, which are bundles of mortgages.
U.S bonds and MBS’s are the safest assets a bank can hold, at least according to regulators. This is why banks tend to invest most of their customer deposits – your money, my American friends – in U.S bonds and MBS’s. These assets earn interest for the banks and thus make it possible for them to offer services with low or no fees.
When interest rates start to rise, however, the value of U.S bonds and MBS’s goes down. If the value of these assets falls too much, then banks can become temporarily insolvent. This insolvency is temporary because when U.S bonds and MBS’s mature – that is, the loan terms end – the bank receives the full value of the underlying asset.
Now, this temporary insolvency is why banks don’t report the losses on U.S bonds and MBS’s when interest rates rise. This is simply because it’s not a loss until they sell. And, in the case of U.S bonds and MBS’s, they won’t lose anything if they hold them to maturity.
However, this accounting practice is controversial. If you watched our video about the collapse of Silicon Valley Bank or SVB, you’ll know that these so-called unrealized losses are fine so long as the bank isn’t forced to sell any of these assets at a loss, i.e., on a customer withdrawals.
The Uninsured Depositors:
92.5% of SVB’s deposits were uninsured by the Federal Deposit Insurance Corporation (FDIC). For context, the FDIC only ensures bank deposits up to $250,000 USD per account. Any amount above that is considered uninsured.
SVB experienced a bank run because its uninsured depositors could see that the bank had lots of unrealized losses. This led to speculation that SVB didn’t have enough money to honor all withdrawals. As such, this bank run probably wouldn’t have happened if most deposits were insured – i.e. under $250k per account.
The reason why SVB had so many uninsured deposits is because the bank provided accounts and banking services primarily to small and medium-sized businesses, startups, and entrepreneurs in Silicon Valley – hence the name. These kinds of clients require lots of cash on hand to pay their employees, make acquisitions, buy coffee, etc., etc.
Now, around $9 trillion USD of bank deposits in the United States are uninsured, which is roughly 50% of all bank deposits. Banks have happily invested these uninsured deposits into U.S bonds and MBS’s. The problem is that interest rates have been rising, and their unrealized losses have been piling up.
At the end of 2022, U.S banks collectively had unrealized losses totaling more than $600 billion USD. Interest rates have risen more since then, which means these losses are likely even larger now. The worst part is that each successive rate hike results in more losses than the previous hike.
The Vulnerable Banks:
U.S banks have lots of unrealized losses and also lots of uninsured depositors, who are concerned that banks can’t honor withdrawals because of these unrealized losses. In the study, the authors examined more than four thousand banks to see which ones were most at risk and why.
For starters, they found that 42% of all bank deposits have been invested into regular MBS’s, with another 24% being invested into commercial MBS’s – i.e., commercial real estate loans, U.S bonds, and other asset-backed securities or ABS’s.
The authors then tried to calculate the unrealized losses on these assets. After crunching the numbers, the authors found the following: “The median value of banks’ unrealized losses is around 9%. After marking to market, the 5% of banks with worst unrealized losses experience asset declines of around 20%.”
In short, U.S banks have unrealized losses, and also lots of uninsured depositors who are concerned that banks can’t honor withdrawals because of these unrealized losses. The authors assess whether banks have enough assets to honor these upcoming withdrawals from uninsured depositors.
The Good News and the Bad News:
The study assumes that the FDIC doesn’t close down banks that come under stress, which is significant because the FDIC is likely to do this if banks really start getting squeezed. The good news is that all but two American banks have enough assets on hand to honor withdrawals from uninsured depositors.
The bad news is that uninsured depositors aren’t rushing to withdraw to earn a higher interest rate elsewhere. However, this is starting to change. Besides the banking crisis, the fact that interest rates are high and still rising in other places is starting to tempt those sleepy uninsured depositors into waking up and moving their money elsewhere.
If they do this, though, banks with large unrealized losses will start going under, as they won’t be able to honor all withdrawals. The authors estimated that as many as 500 other banks could have failed based purely on the unrealized losses. The reason why only SVB went down was because of all those uninsured deposits.
The Safe Haven:
So, what can you do to protect yourself and your deposits? According to the study, crypto could be one of the only truly safe havens. That’s because crypto isn’t tied to any government or bank, and your deposits can’t be uninsured.
In conclusion, it’s essential to be aware of the risk factors when choosing a bank to deposit your money. It’s also crucial to understand how interest rates and accounting practices affect banks’ bottom lines. And, if you’re really concerned, consider investing in crypto as a safe haven for your money.
