Not just your regular bank failure?

Throughout history, many, many, banks have failed. In the US, bank failures are surprisingly common and even in more recent times – the Federal Deposit Insurance Corporation (FDIC) lists 562 bank failures from 2001 to 2023. Most of these were during the global financial crisis (GFC), however there were still 214 banks that failed between 2011 and 2020.

But while many banks, or even corporate collapses are brushed aside by investors, the media and social media, there are a certain few which set alarm bells ringing.

Silicon Valley Bank is one of them. Its size was enough to garner attention - it has assets estimated to be worth $209 billion and is the largest US bank to fail since Washington Mutual in 2008, during the GFC.

However, the world is still on high alert on what can happen upon a major bank collapse. The GFC may have been nearly 15 years ago, but we all still remember where we were, and what happened when the infamous Lehman Brothers collapsed.

So, when the news over the weekend turned into panic and another bank, Signature Bank, failed, authorities knew what to do.

Financial markets barely had time to react before the FDIC and the US Federal Reserve pulled out measures that would limit any further contagion. And these measures are comprehensive. All depositors are guaranteed. Additionally, the Fed has created a Bank Term Funding Program (BTFP).

You can trust a good old central bank acronym to save the day. Importantly, the BTFP allows loans of up to one year to be available to certain financial institutions using US treasuries, agency debt, mortgage backed securities, you know, the ‘safe’ stuff, as collateral. And these assets will be valued at par.

Essentially what it means is this.

It won’t stop customers from simultaneously pulling their money out from a bank which they think are in trouble. But if the FDIC guaranteed all deposit holders for SVB and also Signature Bank, then surely that sends a message they will guarantee deposits for another. It provides some reassurance that their deposits, wherever they are, are going to be fine. The Fed’s BTFP measure also addresses the concern that other banks could also be in similar trouble to SVB with regard to unrealised losses on bond holdings. Banks can now go to the Fed and they will lend money to them for those bonds full face value, which SVB couldn’t do. Even if there were to be another outflow of deposits, those banks can get the money to give back to their owners.

US regulators have well and truly learnt from the GFC what to do in a financial crisis and to prevent contagion. But it doesn’t stop people from being jittery about some other bank, which has a different set of problems, like Credit Suisse.

But the big trouble with SVB is that it reinforced the concerns that we were all looking for in the first place. There are some firm specific problems, but there is one fundamental systemic cause. 

Let’s not forget why we are here.

Rapidly rising interest rates and tighter liquidity was bound to expose some cracks somewhere. Or as some like to call it, ‘something breaking’. If the Fed does continue to lift interest rates, the risk is another casualty could emerge.

For SVB, it was about its bond holdings. If it isn’t bonds, it could be bad position linked to tech stocks, or another of the many assets that have lost a lot of value recently (think crypto).

One big question is if the events over the past week are enough to stop the US Fed from raising interest rates further. That is all going to depend on how successful the Fed’s new funding plan will be at stemming contagion throughout the financial sector.

Given that the Fed and FDIC were quick off the mark in providing comprehensive support to banks (and depositors), there’s a good possibility that it will be enough to calm down markets. It will mean that financial market conditions will only be a little bit tighter and consumers just a bit more cautious. In a couple of months’ time, the jitters would subside. But that will just mean a greater chance that the Fed hikes rates further and that risk of something else breaking will be there again. The Fed has shown that it will step in again, but small fires can turn into big ones.

Alternatively, if the turmoil continues, financial conditions tighten considerably, lending dries up, consumer confidence plummets and with it demand. At least, the Fed will get the weaker economy it wanted to lower inflation.

One way or another, the soft landing that we were all hoping for - it is appearing a lot less likely now.