Bank failures in 2023 have been significant, not because of the total number of failed banks, which is relatively low, but because of the total assets held by the failed banks. The graph above shows how the total from 2023 so far, has surpassed the total from years prior.
Since early March of 2023, the regional banking sector has faced turmoil with the rapid collapses of Silicon Valley Bank (SVB) and Signature Bank, marking three of the largest bank failures in US history within two months. This crisis has been triggered by various factors, including rising interest rates leading to the devaluation of Treasury bonds and mortgage securities, high levels of uninsured deposits, regulatory rollbacks, and lax supervision by the US Federal Reserve.
The crisis began with Silvergate Capital Corporation announcing its voluntary liquidation due to losses from the collapse of the FTX crypto exchange. Subsequently, regulators shut down SVB, known for lending to tech startups and venture capital firms, and Signature Bank, which focused on cryptocurrency customers. First Republic Bank also faced uncertainty, causing concerns of a broader crisis.
These failed banks shared common characteristics: rapid growth with short-term funding, heavy investments in long-term Treasury bonds and mortgage-backed securities susceptible to interest rate fluctuations, and a concentration of uninsured deposits vulnerable to sudden withdrawals. The ability to quickly withdraw funds due to online banking and mobile apps escalated the pace of these bank runs. The US Federal Reserve feared systemic risks and announced measures to guarantee deposits, provide emergency liquidity, and swiftly address troubled banks.
Despite regulatory assurances, investor confidence in regional banks remains low, leading to significant stock drops for banks like PacWest Bancorp and Western Alliance. As the Federal Reserve maintains its rate hikes, regional banks face pressure from both depositors and investors, with insufficient equity bases to withstand major losses. This stress could quickly translate into a credit crunch, particularly impacting small businesses and low-income households relying on regional banks for credit.
The root causes of the banking crisis are multifaceted. While poor management decisions and rapid growth certainly played a role, the interconnectedness of the financial system also contributed. The US Federal Reserve’s focus on controlling inflation led to interest rate hikes that negatively affected regional banks. Regulatory rollbacks under the Trump administration weakened safeguards established after the 2008 crisis, and poor enforcement of existing rules exacerbated the situation.
The ongoing crisis, with yet another regional bank Heartland Tri-State Bank of Elkhart failing in July, raises concerns about the fragility of the entire banking system, as many banks hold massive unrealized losses due to rising interest rates. This vulnerability, coupled with the large amount of uninsured deposits, could trigger more bank runs, potentially destabilizing the system.
While the Biden administration has proposed improvements to bank regulation and oversight, political challenges and the unpredictable nature of digital bank runs make the resolution of the crisis uncertain. The bottom line is that the regional banking crisis in the US is far from over, and the macro environment for vulnerable banks has deteriorated, raising questions about when and how this crisis will end.