What the Heck is Going on With Banks?
What the Heck is Going on With Banks?
Unless you have lived under a rock lately you have likely noticed a bit of commotion swirling around the banking industry, and deservedly so. Over the past couple of weeks, we have seen Silicon Valley Bank (SVB) and Signature bank fail, along with Credit Suisse and First Republic getting bailed out by other big banks. This naturally raises many questions. I’ll attempt to take a very topical issue and give a synopsis at a very high level.
Why the sudden issues?
The biggest question on everyone’s mind is naturally why is this happening? The best way I can take a very esoteric topic and make it more relatable is by distilling it down to two key factors. First, a couple of these banks they have a very niche and NON-DIVERSIFIED customer base. For instance, SVB is based out in California and its clientele are concentrated in tech and startups, while Signature is heavily tied to cryptocurrency. These industries have faced challenges over the last year and its natural for early-stage businesses to burn through cash at a rapid pace.
The second major issue that is compounding these issues is the rapid increase in interest rates. As you likely know, the Fed has aggressively been raising interest rates over the past year plus to combat inflation. One of the unintended consequences of this all out attack on inflation is last year it crushed the bond market. Why does this matter for banks? Well, banks don’t sit on the cash that is deposited in their branches. They tend to either lend those funds out, or very commonly they will buy bonds, in the form of treasuries as they are considered “risk free.”
Now, as interest rates go up, they have an inverse (or opposite) relationship with bond prices. Thus, if you are a bank who has had massive deposits over the past few years, it’s likely that you’ve been forced to purchase government bonds with very low yields. As interest rates get pushed up from the Fed, the bond they’re holding are dropping in value. In a normal environment, the banks wouldn’t necessarily care that the market value of those bonds has fallen as they plan to hold them until they mature and get their entire principal back. The catch here is that their client base has been withdrawing cash quickly and the banks immediate liquidity dried up. What then does happen what does the bank have to do? Sell all these bonds at massive losses to give their depositors back their money. To add insult to injury, when the depositors catch wind that the bank is having liquidity issues it causes a run on the bank, meaning a disproportionate amount of people wanting to withdrawal their money in a short period of time. This is what has lead to this unique and unfortunate set of circumstances.
How to stop it?
The good news is that the Fed, Treasury Department, and other banks have stepped in to contain what could have been a larger issue. There is a combination of ways these entities have stepped in to help. The Fed/gov have said they’ll guarantee all deposits, even in excess of the $250,000 FDIC insured amounts. This was done to contain the run-on withdrawals at some of these banks. This is important because over 90% of the deposits at SVB were uninsured, which aligns with the fact that they did not cater to the average retail customer. Other large banks have stepped in to either purchase these banks, or divisions of these banks, to diversify their portfolios and stem further contagion. Additionally, many of these massive banks have provided a backstop by lending these troubled institutions tens of billions of dollars to give them the liquidity they need to stay afloat.
Is this ’08?
The short answer is no, this is not 2008 all over again. This seems to be a fairly contained issue, but don’t get me wrong if not addressed could have the potential to be a more systemic issue. In the Great Financial Crisis, the problem was more about credit, bad loans, and misunderstood securities.
What should you do?
I’ll never tell anyone not to do their due diligence on a bank and understand their “risks.” That said it is very hard to extract a banks full health as it is a very convoluted topic. While I’m not overly worried, I still believe if you have over $250,000 sitting in your bank under one registration, I’d consider spreading it out over multiple registrations or banks. Or of course you could take advantage of the soft markets and invest it here at Diversified, shameless plug I know.
In any event, times are crazy, but they always seem to be. This is another hiccup on the way to recovery and one that we will get through. We’re always here to answer any questions and as always stay wealthy, healthy, and happy.
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