Lazy eyes listen
According to a paper published this week on the Social Science Research Network, nearly 200 American banks face risks similar to those that led to the implosion and bankruptcy of Silicon Valley Bank (SVB). Last week, regulators shut down SVB, a major US lender focused on the tech and startup sectors, due to massive deposit outflows.
Four economists from prominent US universities conducted the study, estimating how much market value US banks’ assets have lost as a result of recent interest rate hikes.
“From March 7, 2022 to March 6, 2023, the federal funds rate rose sharply from 0.08% to 4.57%, accompanied by quantitative tightening. As a result, long-dated assets comparable to those held on bank balance sheets saw significant value declines during the same period,” they wrote.
Although higher interest rates can help banks by allowing them to lend at a higher rate, many US banks have invested a large portion of their excess cash in US Treasuries. This was done when interest rates were close to zero. Because of the rate hikes, the value of these bonds has decreased significantly; investors can now simply purchase newly issued bonds with a higher interest rate. The decline in the banks’ portfolios is unrealized, meaning the value of the securities has declined but the loss is still only ‘on paper’.
When customers request their deposits be returned, banks are forced to sell their securities at a significant loss in order to repay depositors. In extreme cases, this can cause a bank to become insolvent, or, as happened with Silicon Valley Bank, it can spark a bank run.
The authors of the report investigated how much of US lenders’ funding comes from uninsured deposits: the higher the share, the more vulnerable a bank is to a run. For example, at SVB, where 92.5% of deposits were uninsured, the deposit outflow caused the bank to fail in two days. According to the study’s authors, 186 American banks do not have enough assets to pay all customers if even half of uninsured depositors withdraw their money.
“Our calculations indicate that these banks are almost certainly at risk of a run in the absence of other government intervention or recapitalization… Overall, these calculations indicate that recent declines in bank asset values have “significantly increased the fragility of the US banking system to uninsured depositor runs,” the economists concluded, adding that the number of banks at risk could be “significantly” higher if “uninsured deposit withdrawals cause even minor fire sales.”
The failure of SVB sent shockwaves throughout the US banking industry, leading to the closure of another lender, Signature Bank. Many other financial institutions’ stocks have plummeted, with the six largest Wall Street banks losing roughly $165 billion in market capitalization, or roughly 13% of their total value. Moody’s downgraded its outlook for the US banking system from’stable’ to ‘negative’ earlier this week, citing the “rapidly deteriorating operating environment.”