US Bank failure
PRASHANT PANDIT
Managing Director Red Rock Holdings, Executive Director Universal CLC, Angel investor, Board director.
Silicon Valley Bank and Signature Bank failed with enormous speed, so quickly that they could be textbook cases of classic bank runs, in which too many depositors withdraw their funds from a bank at the same time. The failures at SVB and Signature were two of the three biggest in U.S. banking history, following the collapse of Washington Mutual in 2008.
How could this happen when the banking industry has been sitting on record levels of excess reserves — or the amount of cash held beyond what regulators require?
While the most common type of risk faced by a commercial bank is a jump in loan defaults — known as credit risk — that’s not what is happening here. As an economist who has expertise in banking, I believe it boils down to two other big risks every lender faces: interest rate risk and liquidity risk.
INTEREST RATE: A bank faces interest rate risk when the rates increase rapidly within a shorter period.That’s exactly what has happened in the U.S. since March 2022. The Federal Reserve has been aggressively raising rates — 4.5 percentage points so far — in a bid to tame soaring inflation. As a result, the yield on debt has jumped at a commensurate rate.
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The yield on one-year U.S. government Treasury notes hit a 17-year high of 5.25% this month, up from less than 0.5% at the beginning of 2022. Yields on 30-year Treasury's have climbed almost 2 percentage points.
LIQUIDITY RISK: is the risk that a bank won’t be able to meet its obligations when they come due without incurring losses.
For example, if you spend $150,000 of your savings to buy a house and down the road you need some or all of that money to deal with another emergency, you’re experiencing a consequence of liquidity risk. A large chunk of your money is now tied up in the house, which is not easily exchangeable for cash.
Customers of SVB were withdrawing their deposits beyond what it could pay using its cash reserves, and so to help meet its obligations the bank decided to sell $21 billion of its securities portfolio at a loss of $1.8 billion. The drain on equity capital led the lender to try to raise over $2 billion in new capital.