A new paper from the Social Science Research Network released this week makes the case that almost 200 American banks are facing risks similar to those which led to the collapse of Silicon Valley Bank (SBV). A major US lender which focused on the startup and tech sectors, SVB was seized by regulators after encountering liquidity issues due to a sudden surge of outflows as depositors withdrew their funds.
Written by four economists from prominent universities, the paper examined how much market value US bank assets have lost as the Federal Reserve has hiked interest rates.
The paper found, “From March 07, 2022, to March 6, 2023, the federal funds rate rose sharply from 0.08% to 4.57%, and this increase was accompanied by quantitative tightening. As a result, long-dated assets similar to those held on bank balance sheets experienced significant value declines during the same period.”
Higher interest rates can be an advantage for banks, who are then able to lend money at higher interest rates. However many banks park depositor funds in US Treasuries. When this is done while rates are at near-zero levels, and then interest rates rise, the values of the bonds held by the banks decrease due to the rate hikes, as newer bonds offer increased rates of return. Those declines in bond valuations are unrealized, meaning while the values of the assets have declined, the loss remains only “on paper.”
These losses are realized however when depositors look to withdraw their funds, and the banks are forced to sell the assets at their depreciated values. In the most extreme cases, the banks can become insolvent as the values of the assets they hold is suddenly less than the amount depositors placed with the bank. As with Silicon Valley Bank, a loss of confidence can then trigger a bank run.
The report examined how the percentage of uninsured deposits at a US lender would affect the susceptibility of a bank to a run on deposits. As an example, at a bank like SVB, with 92.5% of its deposits being uninsured, once the run began, it only took two days for the bank to collapse. The study found the greater the percentage of uninsured deposits, the faster a bank will collapse once there is a loss of confidence in it.
The study authors also found that 186 US banks do not have sufficient assets to pay all of their customers if merely half of their uninsured depositors sought to with draw their money.
The study authors wrote, “Our calculations suggest these banks are certainly at a potential risk of a run, absent other government intervention or recapitalization… Overall, these calculations suggest that recent declines in bank asset values very significantly increased the fragility of the US banking system to uninsured depositor runs,” adding that if, “uninsured deposit withdrawals cause even small fire sales,” the number of banks at risk could be “significantly” higher.
SVB’s collapse sent waves of fear through the entire US banking sector, causing the closure of another lender, Signature bank, after it saw a run on deposits. Since then the share prices of many other financial institutions have plunged, as the six biggest Wall Street banks have lost roughly $165 billion in market capitalization, equivalent to about 13% of their total combined value.
Moody’s, the rating agency, downgraded the US banking sector from “stable” to “negative” earlier in the week, noting the “rapidly deteriorating operating environment.”
