Bank Worries
- May 3, 2023
How the current collapse of the banks could just be the beginning.
The collapse of First Republic Bank, along with other major banks, has raised concerns about the possibility of a financial crisis that could resemble the 2007/8 crisis that led to the Great Recession. Three times this year, customers and investors have panicked and rushed to withdraw their money, and the federal government has taken drastic action to prevent a broader panic that could knock down the rest of the financial system. However, nobody knows for certain whether this third time will be the last.
For now, the situation has stabilized, with the stock market holding steady yesterday and other banks appearing to be doing fine. But a crisis has not necessarily been averted. History is filled with examples of leaders who believed they had stopped a disaster but later found they had underestimated the problem, including during the 2007/8 financial collapse. Some analysts worry that other banks may have undiscovered problems, and the Federal Reserve is likely to continue raising interest rates – the very thing that triggered this year’s bank failures.
Things in common
The recent collapse of First Republic Bank, Silicon Valley Bank, and Signature Bank had some important traits in common. First, the banks’ investments were particularly exposed to the risk of rising interest rates. As the Federal Reserve increased interest rates over the past year, many of First Republic’s assets lost value because they were fixed at lower interest rates and, therefore, lower payouts to the bank. Meanwhile, First Republic had to pay now-higher interest rates on its customers’ deposits. The mix of lower revenue and higher costs toppled the bank’s balance sheet.
Second, the three banks had a large share of customers with deposits that surpassed federal insurance limits. These depositors are more likely to be cautious and ready to move their money because they know that they could lose much of it if a bank goes under.
So when First Republic’s investment strategy began backfiring, depositors started to pull out their money in large numbers, causing a classic bank run. By last week, First Republic revealed that customers had withdrawn more than half of the bank’s deposits.
Stabilization of the situation
The three banks’ fates were connected, and the failure of Silicon Valley Bank made Americans more concerned about the safety of their deposits. The threat of further contagion is what led regulators and the financial system to try to stabilize the situation.
The problems largely come down to mismanagement at the three banks, experts said. But regulators share some of the responsibility for failing to spot warnings and to act on them earlier. The Federal Reserve acknowledged as much last week, saying that regulatory changes and a “shift in culture” left regulators unprepared. The Fed also placed some of the blame on Congress, which in 2018 reduced the central bank’s oversight of so-called midsize banks like First Republic and Silicon Valley Bank. The Fed is now considering tougher rules.
Some analysts argue that the worst is over, and the three bank failures were outliers. Their similarities made them unusually vulnerable to the current moment. So far, the government’s swift responses seem to have done a good job of containing the potential contagion.