GRADUALLY, THEN SUDDENLY: HOW BANKS GO BUST

“How did you go bankrupt?” Bill asked.

“Two ways”, Mike said “Gradually, then suddenly”.

Ernest Hemmingway “The Sun Also Rises” (1926)

Part 1: Suddenly

Though we are yet to see an economic recession or a significant deterioration in the credit cycle, three banks, Silicon Valley and Signature in America, and Credit Suisse in Europe, have all just failed. These institutions suffered a collective loss of confidence not just from their investors but crucially from their depositors, who transferred their savings elsewhere, but on which the banks were reliant to fund loans and other investments. Since the banks could not liquidate their assets at a fast enough pace to meet customer withdrawals, they ran out of cash, and were suddenly declared bankrupt.?

What caused the 2023 banking crisis?

We need to start our explanation by returning to the extraordinary stimulus, following the outbreak of the COVID pandemic, which was largely not spent, but saved as bank deposits. In just two years, 2020-2021, the US banking system saw a $4.4trillion (+37%) surge in bank deposits?(See Fig. 1: US Bank Liabilities), whereby deposit liabilities increased from just $14.5trillion in Q1 2020 to $19.9trillion in Q1 2022. Demand for credit in the real economy did not increase commensurately, meaning that over the same two years system bank loans increased by only $390bn (+3%), from $10.96 trillion to $11.35trillion?(See Fig 2. US Bank Assets), leaving US banks with $4 trillion of excess deposits, which at the time cost them almost nothing, but still needed to be invested. The US banking system slowly began drowning in its own liquidity.