What led to recent bank failures in the United States?

Heard of recent bank failures in the United States? What led to the collapse of these banks?

Silvergate Bank 

Silvergate Bank was a commercial bank headquartered in San Diego, California, United States. It announced voluntary liquidation on March 08, 2023. The reasons for its closure are –

Silvergate Bank adopted crypto-currency focused business model in 2014. The boom of crypto market led to rise in deposits from crypto-assets.   | The bank kept most of its deposits in cash or easy-to-sell securities.   | Crypto-assets took a hit after the collapse of FTX crypto exchange in November 2022 and an ensuing criminal investigation.   | There was a surge in withdrawal of deposits, requiring the bank to sell its securities at losses to meet the depositors’ demands.   | The rising losses forced the bank to initiate voluntary liquidation.

Silicon Valley Bank (SVB)

Silicon Valley Bank (SVB) was a commercial bank headquartered in Santa Clara, California, United States. It was defunct on March 10, 2023 after a run on the bank. SVB was the first bank to collapse during March 2023, marking the second-largest bank failure in United States history and the largest since the 2008 financial crisis. The reasons for its failure are –

A large portion of the deposits with SVB came from start-ups and technology companies. During the boom in technology sector, the deposits with SVB increased from $44 billion at the end of 2017 to $189 billion at the end of 2021.   | SVB invested large portion of the deposits in long-dated fixed-income securities such as US government bonds and mortgage-backed securities issued by US government agencies, which carried low interest rates. SVB locked away half of its assets for ten years by investing in these hold-to-maturity (HTM) securities.    |   | Technology industry faced downturn from November 2021.   Due to rising inflation, the US Federal Reserve began to increase interest rates from March 2022.   |   | Due to falling cash flows from the business, the companies started withdrawing their deposits from SVB.   Rise in interest rates increased the cost of market borrowing for the companies, hence, requiring them to withdraw their deposits from SVB.   |   | Sudden demand for large withdrawals compelled SVB to sell-off its securities to meet the depositors’ demands.   The rise in market interest rates reduced the prices of low-interest securities held by SVB, causing distress-sell of the securities at loss.   | | The deposit insurance in the United States covers deposits up to $250,000. As large portion of the deposits was un-insured, it created fear of losing money and led to bank-run, resulting in bank collapse.

What is a bank-run?

Bank-run or run on the bank occurs when large group of customers withdraw their deposits from the bank due to the fear that the bank may fail. Sudden demand for withdrawal of deposits creates a liquidity crisis for the bank, causing it to sell its assets at loss, ultimately leading to bank collapse.

Signature Bank 

Signature Bank was a commercial bank headquartered in New York City, New York, United States. It was defunct on March 12, 2023 due to systemic risk. Signature Bank was the second bank to collapse after Silicon Valley Bank (SVB), making it the third-largest bank failure in United States history. The reasons for its failure are –

Signature Bank began accepting deposits of crypto-assets since 2018.   | Crypto-assets took a hit after the collapse of FTX crypto exchange in November 2022 and an ensuing criminal investigation. | |   Silvergate Bank, another crypto-currency focused bank, announced its voluntary liquidation on March 08, 2023.   SVB collapsed on March 10, 2023 after a run on the bank. | | Liquidation of Silvergate Bank caused fear amongst the depositors of Signature Bank.   Systemic risk caused by the collapse of SVB created fear amongst the depositors. | |   The deposit insurance in the United States, covers deposits up to $250,000. As large portion of the deposits was un-insured, depositors rushed to withdraw their money from the bank. To avoid further panic in the market, the bank was shut down.

What is systemic risk?

Systemic risk refers to a risk of damage to the entire system due to the cascading effect of failure of one entity in the system. 

First Republic Bank

First Republic Bank is a commercial bank headquartered in San Francisco, California, United States. It was defunct on May 01, 2023 marking the third failure of a major US bank in two months. The reasons for its failure are –

Silicon Valley Bank (SVB) collapsed on March 10, 2023 after a run on the bank.   Due to rising inflation, the US Federal Reserve began to increase interest rates from March 2022. |   | As the deposit insurance in the United States covers deposits up to $250,000, the systemic risk caused by the collapse of SVB triggered panic amongst big depositors.   The rise in market interest rates reduced the value of government securities held by First Republic Bank. |   | 11 biggest banks in the United States declared a $30 billion rescue package for First Republic Bank to avoid another bank failure.   | First Republic Bank disclosed that it had suffered more than $100 billion in outflows in the first quarter of 2023 and was exploring options such as restructuring its balance sheet.   | Sharp fall in share prices of First Republic Bank.   | Through a bidding process, JPMorgan agreed to buy most of the assets of First Republic Bank for $10.6 billion. The 84 offices of First Republic Bank became branches of JPMorgan.

How are depositors bailed out?

The US Treasury, the Federal Reserve and the Federal Deposit Insurance Corporation (FDIC) stepped in to refund the depositors of SVB and Signature Bank in full. This will –

1. Contain the spill-over effect of the bank failure to other sectors.
2. Prevent fear amongst the depositors of other banks. However, unlimited bailing out may create ‘moral hazard’ as banks may become indiscipline in managing their risks believing to be bailed out by the government during crisis.

The US Federal Reserve has also announced a one year emergency lending program called Bank Term Funding Program (BTFP) to ensure that eligible banks can meet the needs of their depositors.

What was the impact on India?

The bank failures in the United States led to fall in market capitalisation of stocks in the Indian markets by around ₹10 lakh crore.

Are Indian banks safe?

The Indian banks are considered safe as –

1. Unlike the United States, a major part of bank deposits in India come from household savings instead of corporate deposits.
2. Large part of deposits are with public sector banks and big private sector banks, having trust of the depositors.
3. The various regulatory measures put in place by Reserve Bank of India (RBI) has ensured safe and sound working of the banks in India.

References

Ensign, R. L. (2023, March 08). Crypto Bank Silvergate to Shut Down, Repay Deposits. Retrieved from The Wall Street Journal: https://www.wsj.com/articles/crypto-bank-silvergate-to-shut-down-repay-deposits-4bc2a469

Flitter, M. G. (2023, March 12). Risky Bet on Crypto and a Run on Deposits Tank Signature Bank. Retrieved from The New York Times: https://www.nytimes.com/2023/03/12/business/signature-bank-collapse.html

Hayes, A. (2023, March 21). What Is The Bank Term Funding Project? Retrieved from Investopedia: https://www.investopedia.com/bank-term-funding-project-7367897

Reuters. (2023, May 02). 'Why First Republic Bank failed and what JP Morgan’s deal means'. Retrieved from https://indianexpress.com/article/explained/explained-economics/why-first-republic-bank-failed-jpmorgan-deal-explained-8586416/

Rob Copeland, L. H. (2023, March 16). Wall Street’s Biggest Banks Rescue Teetering First Republic. Retrieved from The New York Times: https://www.nytimes.com/2023/03/16/business/first-republic-bank-sale.html

Turner, J. (2023, March 17). Why did Silicon Valley Bank fail? Retrieved from Economics Observatory: https://www.economicsobservatory.com/why-did-silicon-valley-bank-fail

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