The recent failures of Silicon Valley Bank and Credit Suisse have raised concerns about the stability of the U.S. banking system.
Regulators and business leaders have attempted to reassure the public that banks are safe and that measures have been taken to prevent contagion throughout the financial system. However, the underlying issues that led to these failures remain a cause for concern.
The backstopping of all depositors, both insured and uninsured, at Silicon Valley Bank and Signature Bank by the FDIC, Federal Reserve, and Treasury has been an important step to prevent a broader financial crisis.
This action, coupled with the public reassurances from officials such as Treasury Secretary Janet Yellen and Citigroup CEO Jane Fraser, has helped to restore confidence in the banking system.
However, the reasons for the failures of Silicon Valley Bank and Credit Suisse highlight underlying issues within the banking system that have yet to be fully addressed.
Silicon Valley Bank’s poor risk management and heavy unrealized losses caused by rising interest rates illustrate the vulnerability of banks to external factors beyond their control. The fact that U.S. banks as a whole have $1.7 trillion in unrealized losses at the end of 2022 suggests that this is not an isolated issue.
Fragility of the U.S. Banking System
The decline in asset values due to rising interest rates has further exposed the fragility of the U.S. banking system. With U.S. banks’ assets losing 10% of their value in the past year alone, the potential for future failures cannot be ignored. The fact that nearly $7 trillion of the $17 trillion in total U.S. bank deposits are uninsured by the FDIC further complicates the situation.
If even a small percentage of uninsured depositors withdraw their funds after recent bank failures, it could put hundreds of billions of dollars of deposits at risk, potentially leading to a broader financial crisis.
The accounting practice of holding assets on banks’ books at their purchase value rather than their current market value means that banks’ unrealized losses are not reflected on their balance sheets. These losses only become realized if the bank is forced to sell its holdings due to a bank run where depositors withdraw their funds en masse.
This is what occurred with Silicon Valley Bank, where depositors demanded their funds back, causing the bank to sell its mortgage-backed securities holdings at a loss.
However, as JPMorgan analysts note, $1 trillion in deposits have already been pulled from the “most vulnerable” U.S. banks after Silicon Valley Bank’s collapse, increasing the chances of facing unrealized losses and leading to more bank runs. If this trend continues, it could cause significant problems for the U.S. banking system.
